16 - Remuneration of directors and senior execs Flashcards
6 reasons why remuneration is such an important CG issue
- Remuneration is a very important aspect of attracting and retaining talented execs
- Remuneration incentives can be used to motivate executives to achieve better results for the company
- It is pivotal to not reward directors for failure
- Incentive schemes need to be aligned with interests of shareholders
- High levels of exec pay can undermine public trust
- Directors should not be able to decide or influence their own remuneration
5 components of executive remuneration
- Basic salary
- Payments into pension scheme
- Annual bonus
- Long-term incentives - share options and share grants
- Other benefits - such as company car
2 elements of remuneration pay that components can be divided into
- Fixed
- Variable
Which components of remuneration make up fixed element?
- Salary
- Pension contributions
- Other benefits
What can variable element of remuneration pay be divided into?
- Short-term incentives - usually cash
- Long-term incentives - share options or share grants
How are annual bonus payments typically achieved?
Meeting financial performance targets
5 KPIs for financial performance re. short term remuneration
- EPS (profits divided by shares in issue)
- Profit before interest and taxation (PBIT)
- Total shareholder return (dividend and share price appreciation)
- Earnings before interest, taxation, depreciation and amortisation (EBITDA)
- Return on capital employed (ROCE)
Explain deferred annual bonus schemes
Company may offer to provide annual bonus either in full or part as shares in the company. Usually held on trust for 3 years
Why is a share option a long-term incentive for execs?
Exercise price is fixed, typically at market value at time of issuing. The more that the share price rises before the option is exercised, the more of a good deal (and opportunity for immediate profit) the director gets.
Typically 10 year max on exercising
Explain grants of shares
‘Performance shares’, ownership of which will be conditional on achievement of targets.
Closer to target, higher % of shares awarded
2 most common performance measures for long-term incentives
EPS & TSR
Grant Thornton CG Review 2018
9 problems/considerations in linking remuneration with co’s performance
- Whether to include non-financial targets
- Setting thresholds (obtainable but challenging)
- Whether to place a cap
- Ensuring targets promote LT success
- Ensuring targets do not promote bad behaviour
- Difficulties in isolating each execs performance
- Difficult to prevent new execs benefitting from legacy effects
- Directors may expect rewards regardless of success
- Major shareholders should consider scheme satisfactory
Use of comparative pay data in remuneration
Companies may decide to base fixed and/or variable remuneration on that of competitors
Issue to consider with comparative remuneration pay
If all companies in comparative group decide to pay above average pay, pay will spiral up and up
3 drawbacks to using share options for long-term incentive schemes
- Shareholders may prefer dividends, and execs may have interest in keeping dividends low until options are exercised
- Share prices may rise in line with general stock market rise, rather than co’s success (vice versa)
- Share option will not provide any incentive if share price drops
Meaning behind provision 35 - ‘Independent judgement should be exercised when evaluating advice of third parties [on remuneration]’
Remuneration committee should not blindly follow recommendations of remuneration consultants
According to Code, should NEDs’ remuneration be performance based?
No
How does UKCG Code define ‘senior management’
The executive committee or the first layer of management below board level (including the CoSec)
Are the board responsible for remuneration consultants?
No, the remuneration committee are
3 main concerns over remuneration consultants
- Objectivity
- Believed to have played role in promoting spiralling exec pay
- Intentionally complex
3 reasons behind concerns on remuneration consultants
- CoIs if engaged by execs to advise on other aspects or if connected to an exec, meaning they may make recos which favour execs over company
- Inclined to recommend complex schemes to raise their fees and make them harder to dispense of
- Execs, senior management and consultants themselves may put pressure on rem com to accept advice
Rem Com report for quoted co’s must include: (2)
- Details regarding membership of committee
- Statement summarising major decisions made in relation to remuneration, and context
Quoted companies reporting requirements on remuneration under CA 2006
Directors’ remuneration report, including:
- the remuneration policy if it is to be put to shareholders
- Annual remuneration report giving details of payments
Maximum time that quoted or traded co can go without having remuneration policy approved
3 years (even if no changes)
Where must remuneratIon policy be made available
Company’s website
Difference between directors’ remuneration report and annual remuneration report
Annual remuneration report is 1 of 2 components of director’s remuneration report
Significance of service contract in terms of pay (2)
- Will provide for annual review of remuneration
- Provide for minimum notice period in event of dismissal
What does CA 2006 say on length of service contracts?
More than 2 years requires shareholder approval
Look at Code - service contracts - 2 key points
- 1 year or less
- Compensation commitments should not reward poor performance
Which Code provision relates to malus and clawback provisions?
Provision 37
What are ‘malus’ provisions?
Allow the company, in specified circumstances, to forfeit all or part of bonus or long-term incentive award before it has been vested and paid
What are ‘clawback’ provisions?
Allow the company to recover the sums already paid
FRC’s board effective guidance states circumstances which should allow for ‘malus’ and ‘clawback’ (to be decided by rem committee) should include: (5)
- Payments based on erroneous or misleading date
- Misconduct
- Misstatement of accounts
-Serious reputational damage - Corporate failure
How are terms of NEDs appointment set out?
In a simple letter of appointment
Who sets NEDs fees?
Usually the board, to avoid NEDs on rem com setting own remuneration
What form of payment do NEDs usually receive?
Fee for services - cash
See Code Provision 34
3 reasons why it is considered inappropriate for NEDs to have pay based on co’s performance
- Would involve CoI for those on rem com in designing performance schemes
- Interests of NEDs would become more closely aligned with execs than shareholders
- NEDs do not have such a great impact on co’s performance as execs
What should fees paid to NEDs reflect?
The time commitment and responsibilities they undertake in the role
How often will quoted co’s remuneration report be put to a vote by shareholders? - advisory vote
Annually (at AGM)
What if remuneration report is rejected by shareholders at ‘advisory vote’?
Revised policy needs to be put to next accounts meeting and voted on
3 key elements of directors’ remuneration policy
- Table describing each component of the remuneration package
- Statement of the principles which are applied
- Bar chart indicating minimum and maximum amounts
5 considerations when approaching setting basic salary levels of directors
- Any remuneration awarded to execs for next FY must be consistent with current remuneration policy approved by shareholders
- Remuneration consultants should typically be used
- Benchmarking against comparator companies
- Consulting with shareholders
- Workforce remuneration and consultation
Look at Code - what are the primary principles and provisions to consider when reviewing/deciding remuneration?
Principles P & R
Provision 40
Use of remuneration consultants to assist with determining exec pay (3)
Accepted practice that Rem Com use remuneration consultants to advise on levels of director pay
Rem Com should not blindly follow advise and should ultimately apply its own judgement
Concerns over rem consultants should be considered (objectivity & role in spiralling remuneration)
Use of benchmarking in determining salary levels of execs (4)
Information about the level of salaries of directors of comparator companies can be considered
Information is typically provided by remuneration consultants
Comparator companies appropriately chosen based on size and business sector
Pay structures should not be based solely on benchmarking as this can lead to ratcheting (spiralling) effect on executive pay
Importance of consulting with shareholders when determining executive remuneration (2)
20% or more votes against the remuneration report triggers obligation to consult with shareholders under Code
Annual report requirement to state what engagement has taken place with shareholders and the impact that had on remuneration outcomes
Look at Code - where in code does it state the disclosures in annual report on how remuneration has been set?
Provision 35 & Provision 41
Consideration of workforce remuneration and consultation when setting exec remuneration (2)
Rem Com is required under Code (Provision 33) to review workforce remuneration when setting policy for exec remuneration
Reference to pay ratios are required when providing reasons why chosen exec pay level is appropriate
CA 2006 requirements on directors’ remuneration policy
Under CA2006, listed companies must seek approval from shareholders for directors’ remuneration policy: at least every three years, if they wish to revise the policy, or if the directors’ remuneration report was not approved by advisory vote at previous AGM.
A listed company cannot make any payments to a director unless they are consistent with the latest policy
Look at code - which provision relates to preventing rewards for failure? What are the two aspects
37
- Malus and clawback
- Use of discretion
5 considerations when approaching a long-term incentive plan question
- Companies Act restrictions
- Code principles and provisions
- Preventing rewards for failure (use of discretion and malus and clawback)
- Consulting with shareholders
- Performance measures
Performance measures under an LTIP (3)
Non-financial and financial measures should be considered
Remuneration consultants could be used to assist in designing the targets
Financial measures
- TSR (share appreciation + dividends)
- EPS (income / shares in issue)
Non-financial measures
- Employee retention
- Environmental targets
- Customer satisfaction
3 non-financial measures that can be used for LTIPs
- Employee retention
- Environmental targets
- Customer satisfaction
3 instances whereby remuneration policy must be put to shareholders for approval
- 3 years since policy last approved
- Company wishes to revise policy
- Directors’ remuneration report not approved by advisory vote of shareholders at previous AGM
What is the typical performance period considered under LTIPs?
3 years
