Remuneration of directors Flashcards
State Principle 14 of the King IV Code on remuneration
The governing body should ensure that the organisation remunerates fairly, responsibly and transparently so as to promote the achievement of strategic objectives and positive outcomes in the short, medium and long term
Explain the concepts “fair remuneration”, “responsible remuneration” and “transparent remuneration”
‘Fair remuneration’ for an individual should be fair relative to that of other individuals with similar skills, aptitude, application and achievement within the organisation and in similar organisations in society; it should also be fair in relation to the value created by the individual
‘Responsible remuneration’ conveys (communicates) a sense of fiduciary duty of the governing body to avoid excessively high or low pay levels and to avoid policies that may be detrimental to the organisation or to society
‘Transparent remuneration’ implies granting public access to details of remuneration, as well as an explanation of how remuneration is determined
State the recommended practices on the remuneration policy
• The governing body should assume responsibility for the governance of remuneration by setting the direction for how remuneration should be approached and addressed on an organisation-wide basis
• The governing body should approve a policy that articulates and gives effect to its direction on fair, responsible and transparent remuneration
• The remuneration policy should be designed to achieve the following objectives:
a. To attract, motivate, reward and retain human capital
b. To promote the achievement of strategic objectives within the organisation’s risk appetite
c. To promote positive outcomes
d. To promote an ethical culture and responsible corporate citizenship
• The remuneration policy should address organisation-wide remuneration and include provision for the following specifically:
a. Arrangements towards ensuring that the remuneration of executive management is fair and responsible in the context of overall employee remuneration in the organisation
b. The use of performance measures that support positive outcomes across the economic, social and environmental context in which the organisation operates, and/or all the capitals that the organisation uses or affects
c. If the organisation is a company, the voting by shareholders on the remuneration policy and implementation report, and for the implementation of related responding measures
• All elements of remuneration that are offered in the organisation and the mix of these should be included in the remuneration policy, including:
a. base salary, including financial and non-financial benefits;
b. variable remuneration, including short and long-term incentives and deferrals;
c. payments on termination of employment or office;
d. sign-on, retention and restraint of payments;
e. the provisions, if any, for pre-vesting forfeiture (malus) and post-vesting forfeiture (claw-back) of remuneration;
f. any commissions and allowances; and
g. the fees of non-executive members of the governing body
State the recommended practices on the remuneration report in its three parts
The governing body should ensure that remuneration is disclosed by means of a remuneration report in three parts:
a. a background statement
b. an overview of the main provisions of the remuneration policy
c. an implementation report which contains details of all remuneration awarded to individual members of the governing body and executive management during the reporting period
Recommended practices: A background statement
The background statement should briefly provide context for remuneration considerations and decisions, with reference to:
a. internal and external factors that influenced remuneration
b. the most recent results of voting on the remuneration policy and the implementation report and the measures taken in response thereto;
c. key areas of focus and key decisions taken by the remuneration committee during the reporting period, including any substantial changes to the remuneration policy
d. whether remuneration consultants have been used, and whether the remuneration committee is satisfied that they were independent and objective
e. the views of the remuneration committee on whether the remuneration policy achieved its stated objectives; and
f. future areas of focus
Recommended practices: An overview of the main provisions of the remuneration policy
• The overview of the main provisions of the remuneration policy should address the objectives of the policy and the manner in which the policy seeks to accomplish these. The overview should include the following:
a. The remuneration elements and design principles informing the remuneration arrangements for executive management and, at a high level, for other employees
b. Details of any obligations in executive employment contracts which could give rise to payments on termination of employment or office
c. A description of the framework and performance measures used to assess the achievement of strategic objectives and positive outcomes, including relative weighting of each performance measure and the period of time over which it is measured
d. An illustration of the potential consequences on the total remuneration for executive management, on a single, total figure basis, of applying the remuneration policy under minimum, on-target and maximum performance outcomes
e. An explanation of how the policy addresses fair and responsible remuneration for executive management in the context of overall employee remuneration
f. The use and justification of remuneration benchmarks
g. The basis for the setting of fees for non-executive directors
h. A reference to an electronic link to the full remuneration policy for public access
Recommended practices: The implementation report
• The implementation report, which includes the remuneration disclosure in terms of the Companies Act, should reflect the following:
a. The remuneration of each member of executive management, which should include in separate tables
i. A single, total figure of remuneration, received and receivable for the reporting period, and all the remuneration elements that it comprises, each disclosed at fair value
ii. The details of all awards made under variable remuneration incentive schemes in the current and prior years that have not yet vested, including the number of awards; the values at date of grant; their award, vesting and expiry dates (where applicable); and the fair value at the end of the reporting period
iii. The cash value of all awards made under variable remuneration incentive schemes that were settled during the reporting period
b. An account of the performance measures and the relative weighting of each, as a result of which awards under variable remuneration incentive schemes have been made, including: the targets set for the performance measures and the corresponding value of the award opportunity; and for each performance measure, how the organisation and executive managers, individually, performed against the set targets
c. Separate disclosure of, and reasons for, any payments made on termination of employment or office
d. A statement regarding compliance with, and any deviations from, the remuneration policy
Explain the process of voting on remuneration
• In terms of the Companies Act, fees for non-executive directors for their services as directors must be submitted for approval by special resolution of shareholders within the two years preceding payment
• The remuneration policy and implementation report should be tabled every year for separate non-binding advisory votes by shareholders at the AGM
• The remuneration policy should record the measures that the board commits to take in the event that either the remuneration policy or the implementation report, or both, have been voted against by 25% or more of the voting rights exercised. Such measures should provide for taking steps in good faith and with best reasonable effort towards the following at a minimum:
a. An engagement process to ascertain the reasons for the dissenting votes
b. Appropriately addressing legitimate and reasonable objections and concerns raised, which may include amending the remuneration policy, or clarifying or adjusting remuneration governance and/or processes
• In the event that either the remuneration policy or the implementation report, or both, were voted against by 25% or more of the voting rights exercised, the following should be disclosed in the background statement of the remuneration report succeeding the voting:
a. With whom the company engaged, and the manner and form of engagement to ascertain the reasons for dissenting votes, and
b. The nature of the steps taken to address legitimate and reasonable objections and concerns
State section 30(6) of the Companies Act in relation to remuneration
• According to s 30 (6) of the Companies Act 2008, ‘remuneration’ includes:
a. fees paid to directors for services rendered by them to, or on behalf of, the company, including any amount paid to a person in respect of the person’s accepting the office of director;
b. salary, bonuses and performance-related payments;
c. expense allowances, to the extent that the director is not required to account for the allowance;
d. contributions paid under any pension scheme not otherwise required to be disclosed in terms of subsection (4)(b);
e. the value of any option or right given directly or indirectly to a director, past director or future director, or a person related to any of them, as contemplated in section 42;
f. financial assistance to a director, past director or future director, or a person related to any of them, for the subscription of shares, as contemplated in section 44; and
g. with respect to any loan or other financial assistance by the company to a director, past director or future director, or a person related to any of them, or any loan made by a third party to any such person, as contemplated in section 45, if the company is a guarantor of that loan, the value of—
i. any interest deferred, waived or forgiven; or
ii. the difference in value between—
• the interest that would reasonably be charged in comparable circumstances at fair market rates in an arm’s length transaction; and
• the interest actually charged to the borrower, if less.
Elements of remuneration: Base pay
- This is also referred to as ‘total guaranteed pay’ (TGP) and refers to all components of remuneration that are guaranteed, including base salary and benefits, if any, that typically accrue on a monthly basis such as housing allowance, medical aid scheme or the employer’s contribution to a pension fund
- Base pay must be the starting point when one considers a remuneration structure for full time employees.
- In setting the levels of base pay, the remuneration committee should be careful to select an appropriate comparator group for purposes of comparing rates of pay. For most organisations and bearing in mind public concern over excessive bonus levels, it is wise to set the base pay as a reasonably high proportion of the remuneration package. By so doing, the committee is able to keep the bonus scheme flexible so that it can reduce the variable portion of the package when circumstances so dictate. However, for executive management it is regarded as good practice to have relatively higher levels of variable pay
Elements of remuneration: short-term incentive schemes
- Also known as annual incentives, it refers to all cash-based payments that are paid to an individual based on company and individual performance measured over a 12-month period.
- The most common form of short-term incentive scheme for executives is an annual bonus, usually in cash, although there has been a recent trend to offer deferred shares instead (A deferred share is a share that does not have any rights to the assets of a company undergoing bankruptcy until all common and preferred shareholders are paid)
- Short-term incentives should be based on performance, generally measured over a fairly short period, such as a financial year
- When measuring performance, great care is needed to ensure that the targets chosen are relevant, consistent with strategy and shareholder goals, and simple to calculate. These targets should also encourage behaviour to support the long-term sustainability of the company, and not merely short-term profits. Each year the targets should be re-assessed to ensure that they remain relevant
- Where incentives are given for long-term goals as well as short-term, the performance drivers should not be duplicated. To avoid the danger of manipulation, multiple performance measures may be used but care should be taken not to over-complicate the incentive scheme
- Remuneration should be related to the market, the size of the business, and its complexity and location, and these aspects should be clearly explained to shareholders in the remuneration report
Elements of remuneration: long-term incentive schemes
• Long-term incentive schemes refer to structures (often a combination of cash and equity-based awards) implemented by the organisation to encourage long-term performance, generally measured over 3 to 5 years or longer
• These schemes are often related to the company’s shares, for example by granting an option to acquire shares in future, or by rewarding employees (in cash or shares) for growth in the share price. Long-term incentives relating to shares work well for listed companies, as the market and trading mechanisms for the company’s shares already exist. Unlisted companies will often offer long-term incentives that are calculated based on the growth in the value of the company, but that do not actually involve trading of the company’s shares
• In line with King IV’s admonition to pursue a responsible remuneration policy, it is desirable that companies should avoid highly leveraged incentive schemes that may involve excessive risk or cost. Highly leveraged schemes pay out large bonuses in relation to base pay. Instead it makes sense to:
a. Make regular annual grants of share incentive awards, thus avoiding the volatility inherent in large infrequent grants
b. Measure performance over the company’s financial year, and
c. Reduce the likelihood of ‘underwater’ or ‘out of the money’ options on the one hand (those where the market price has fallen below the ‘strike price’ that the option-holder would pay for the shares) and excessive gains on the other
State the reason for the use of share-based incentives as form of executive remuneration
Share options were introduced as a form of executive remuneration on the basis that they align the interests of the recipients with those of shareholders on the reasoning that an increase in the value of the shares benefits both the executive holding the option and the shareholders
State the disadvantages of share-based incentives as form of executive remuneration
a. When an option is ‘out of the money’ (that is, when the share price does not grow and the strike price ends up being more than the value of the share), it may be perceived as worthless by the executive who holds it. This can be de-motivating
b. While the market price of a share exceeds the strike price of an option over shares of that class (i.e. while they are in the money), then the values of both the share and the option move together, but when the options are out of the money, the two values behave differently. The result is that share options only result in a true alignment of interests between executives and shareholders while the options are in the money
c. Once options are exercised and executives sell the shares, their interests cease to be aligned with those of shareholders
d. IFRS 2 now requires companies to treat the value of share options granted as an expense, but in South Africa the expense is not deductible for tax purposes even though the benefit is usually taxable in the hands of the executives
e. Because stock markets do not necessarily mirror company performance, executives sometimes earn large benefits from share options in spite of poor personal and company performance, and vice versa.
State the improvements made to share-based incentives
a. Limits are being placed on the degree of dilution that an option scheme may produce and on the extent of individual participation
b. To a large extent phased grants, usually awarded annually, have taken the place of single tranches
c. Grants are usually awarded based on a sliding scale in relation to the base salary and performance of individual executives
d. The vesting of options does not always depend simply on the passing of time but on the achievement of performance conditions set by the company
e. More companies are requiring executives to retain shares acquired under incentive plans so as to build a shareholding in the company that is material relative to the remuneration level and gives the executives ‘skin in the game’ (have a personal investment in an organisation and therefore a vested interest in its success)
f. Instead of or in addition to options, many companies are making use of conditional share awards that are dependent on the achievement of company performance targets
g. Share incentive plans are structured to be tax-deductible in the hands of the employer
h. Deferred bonuses are also used as a retention tool. This is usually done by requiring the executive to purchase shares in the company with the proceeds of his annual bonus. After a period of a few years, a matching award of shares is made to the executive, often after the achievement of performance conditions
