Topic 2 - Directors' Remuneration Flashcards
‘Good’ governance drivers* in terms of directors remuneration
- Provision of long term incentives tied to company performance
- Pay set by an independent remunerations committee
- Disclosure of pay
Shareholder and public concerns pre-Greenbury (1995)
- Large pay rises seemingly unrelated to performance
• Large gains from share options with little information disclosed to shareholders
• Privatised utilities – huge pay rises and option gains as a result of privatisation – Yet staff reductions and pay restraints in privatised companies
• Compensation for loss of office – ‘rewards for failure’
• No accountability for directors’ remuneration
Linking of performance and reward
Separation of ownership & control (Performance and reward is linkedin to agency theory)
• Principals and agents – maximise own returns
• Managers more risk adverse than owners they have more at stake with the company failing. They need an incentive element, a reward for taking successful risk.
– Need to trade-off incentive and risk
– Remuneration needs to comprise of both incentive and insurance elements
• Eliminate divergence of interests by:
– Introduction of incentive-based contracts
– Rewards tied to long-term performance of the company
– L-Tips – conditional share rewards & share options
Issues with agency theory perspective
Defining the optimal mix of incentive (risktaking) and insurance (risk-bearing) elements of compensation – will depend on the characteristics of the individual directors.
• Firm performance is a very noisy signal of an agent’s effort.
• Assumes that shareholders design and implement compensation contracts for directors.
- In reality, shareholders don’t see director’s remuneration contracts. They have a very limited role.
Empirical evidence
Indicates weak link between executive remuneration and corporate performance(Conyon, 1997)
• Main et al (1996) included share option schemes which when included the sensitivity of compensation to corporate performance increased considerably.
• Firm size is the most significant and consistent determinant of remuneration.
- The bigger the fir, the more you get paid. CEOs are incentivised to takeover and acquire other firms because they’ll get paid more.
Empirical evidence (Problems of research)
– incomplete disclosure prior to Greenbury
– exclusion of long-term compensation
– complexity of measuring and valuing total remuneration (basic pay, bonus, options, LTIPs, pension, etc.
- One of the roles of the renumeration consultant is to make the contracts as complicated as possible so outsiders wont understand it.
Cadbury Report (1992)
Executive directors’ remuneration should be subject to the recommendations of a remuneration committee comprise wholly or mainly of NEDs. (non-exec directors)
• Full disclosure is required of total and the highest paid director. However you just knew the amount not who it was.
• Executive directors’ contracts should not exceed three years without shareholder approval.
Greenbury Report (1995)
Set up in January 1995 with terms of reference:
“To identify good practice in determining Directors’
remuneration and prepare a Code of such practice for
use by UK plcs.”
• Cadbury recommendations on the use of remuneration
committees led to the accusation that remuneration
committees simply acted as a legitimising device to
ratchet up pay.
• Report found some “mistakes and misjudgements” , but
most companies dealt with remuneration in a “sensible
and responsible way”
• UK levels of directors’ remuneration comparable with
Europe, below US.
Corporate performance was largely dependent upon the quality of directors
• “The remuneration packages UK companies offer must, therefore, be sufficient to attract, retain and motivate Directors and managers of the highest quality.”
• No radical changes proposed in terms of setting pay
• Radical proposals in terms of disclosure - aiming that accountability is improved
- Radically improved disclosure, however, there were no changes in terms of pay because the UK needed to be able to attract and retain top talent.
The remuneration committees should comprise exclusively of independent NEDs (minimum of three independent NEDs).
• The remuneration committee should report to shareholders annually. (The Remuneration report)
• Full disclosure is required of all elements of the
remuneration package (including share options
and pension entitlements) of each named director. (Much more detail is now provided and directors are appalled because they thought it was a breach of their privacy)
• Remuneration report should provide an explanation of the company’s policy on the setting of executive remuneration.
Executive directors’ contracts exceeding one year should be disclosed and explained.
• Shareholders’ approval is required for the adoption of long-term incentive plans.
• Share options should never be issued at a discount, should be phased in rather than issued in one block and should not be exercise-able in under three years.
Remuneration policy
Packages to attract, retain and motivate directors of quality required
• Avoid paying more than necessary
• Judge where to position their company relative to other companies
• Performance-related elements designed to align
interests of directors and shareholders
Effect of Greenbury
Significant increase in the amount of disclosure required.
• Led to accusations that the volume of information had become a ‘barrier to effective communication’ (Ernst and Young , 1996).
• Fuelled the argument that governance codes led to increased bureaucracy and burdens on companies without providing real benefits to shareholders
- The disclosure became a barrier to communication because the information was so complicated to understand.
- They purposely made it harder for shareholders to understand how much they were paid.
Hampel Report (1998) - findings and recommendations
Greenbury’s aim of full disclosure of remuneration matters achieved.
Warning against measures to limit executive remuneration. Told the govt not to restrict pay.
• Economic performance would be damaged if unable to attract directors of sufficient calibre
• Little change from Greenbury regarding remuneration.
Impact of codes
Heavy reliance on non-exec directors to set appropriate levels of remuneration
• Conyon identifies 3 problems:
1. Information asymmetries
2. ‘interlocking directorships’ (director serves on multiple boards)
3. Nomination of NEDs often by executives whose rewards they must determine
Accountability
- The Greenbury report recommended remuneration committee’s report should set out the company’s policy on major issues such as
- “how performance is measured, how rewards are related to it, how the performance measures relate to longer-term company objectives and how the company has performed over time relative to comparator companies.”
- 1999 PWC survey found fairly high levels of nondisclosure regarding incentive schemes.
Directors’ Remuneration Report Regulations 2002
Purpose of the legislation is to
– Enhance transparency in setting directors’ pay;
– Improve accountability to shareholders
– Provide for a more effective performance linkage.
• Requires quoted companies to publish a remuneration report. Comply or explain does not apply.
• Each year table a resolution on the directors’ remuneration report
• Vote will be advisory & not require shareholders to
approve specific levels of remuneration.
- Shareholders vote to accept or reject remuneration report in full at the annual general meeting
- This is an advisory vote. The company can’t do anything since the director is already paid. It is essentially a warning for next year.
Directors’ remuneration report must include:
- Board’s procedures relating to directors’ remuneration, particularly the role of the remuneration committee
- Company’s forward looking policy, including details of, and an explanation of, performance criteria for long term incentives schemes;
- Details of each director’s remuneration in the preceding financial year;
- Performance graphs, which will provide historic information on the company’s performance against relevant criteria
