EXECUTIVE REMUNERATION – THE CAUCUS RACE?A Report to the International Corporate Governance Network. July 2002 ‘What is a Caucus-race?’ said ‘Why,’ said the Dodo, ‘the best way to explain it is to do it.’ First it marked out a race-course, in a sort of circle, (‘the exact
shape doesn’t matter,’ it said) and then all the party were placed along the
course, here and there. There was no ‘one, two, three and away,’ but they
began running when they liked, and left off when they liked, so that it was
not easy to know when the race was over. However, when they had been running
half-an-hour or so, and were quite dry again, the Dodo suddenly called out,
‘The race is over!’ and they all crowded around it, panting and asking ‘But
who has won?’ This question the Dodo could not answer without a great deal of
thought, and it sat a long time with one finger pressed upon its forehead,
(the position in which you usually see Shakespeare, in the pictures of him,)
while the rest waited in silence. At last the Dodo said, ‘Everybody has won, and all must have
prizes.’ *** INTRODUCTION 1.
The subject of executive remuneration, a word with
which even native English-speakers have difficulty, dominates discussions of
corporate governance. There are two reasons for this: nothing fascinates the
average reader more than the ‘how much?’ question. At a more sophisticated
level, boards awarding themselves money from their shareholders’ assets
potentially creates a direct conflict of interest between the owner and the
agent that is not present in almost all other areas of managerial activity.
Unfortunately, because there is little consensus between company managers and
their owners’ other agents, the institutional investment managers, about this
area, the debate drowns the perfectly sensible discussions about other areas
of governance that may have a more direct effect on the long-term success of
the companies concerned. It also consumes large amounts of time, for company
managers and investors alike, with limited effect. 2.
The ICGN has asked this committee to see whether
we can agree between ourselves what features of executive compensation
schemes are most likely to meet the needs of both the company managers and
the investing institutions and their clients. This report is the outcome of
our discussions. The Committee has been carefully constructed to have
contributions from institutional investors from different economic and social
models, from the remuneration and executive search consultancy world, and, most important, a senior HR executive from a
truly global company. The risk is that, with such a diverse membership, we
might only have been able to agree on a ‘lowest common denominator’
structure, but I hope that, in the event, we have made more progress than
that. 3.
We present our conclusions to the ICGN for
discussion and approval, and believe that this paper will help create a
consensus about the structure of remuneration packages around the world that
both company and investment managers will accept. They represent guidance to
what we see as best practice for remuneration committees and investors, in
the same way that the OECD has published a more general view of corporate
governance. BEST PRACTICE FOR REMUNERATION 4.
The fundamental requirement for executive
remuneration reporting is TRANSPARENCY. The base salary, short-term and
long-term incentives, as well as other payments and benefits for all
main-board directors, should be published (paragraph 52). 5.
Remuneration committees should publish statements
on the expected OUTCOMES of the remuneration structures, in terms of ratios
between base salaries, short-term bonuses and long-term rewards, making both
‘high’ and ‘low’ assumptions as well as the ‘central’ case, (paragraphs 43,
53). 6.
We accept that share OPTIONS, although not ideal
vehicles, will continue to play a part in remuneration packages. We believe
they should not be the only means of creating longer-term incentives. They
should also be issued regularly, rather in one large batch. This should
obviate the need for repricing. In exceptional
circumstances, a company should put any proposal for repricing
to its shareholders through a vote at an annual meeting. Shareholders would
be better served if the vesting period for options was to be no less than
three years in most circumstances, (paragraphs 37-42). 7.
The Committee supports the attempts by the IASB to
make the true cost of options
(and any other benefits) a charge to the revenue account (paragraph 35). 8.
The Committee recommends that a remuneration report be presented as a
separate voting item at every annual meeting (paragraph 54). 9.
Remuneration Committees should have the ultimate
say over the appointment of and terms on which remuneration consultants are recruited (paragraph 48). 10.
Companies should not lend to their directors, or
set up remuneration schemes by which executives are substantially incentivised separately from the outcome to shareholders
(paragraphs 29, 43). 11.
The Committee is opposed to the payment of cash
TRANSACTION BONUSES on the completion of take-overs or mergers (paragraph
34). 12.
Investing institutions need to increase the
resources being addressed at the analysis of remuneration resolutions
(paragraph 51). BACKGROUND 13.
The world of executive remuneration is dogged by a
series of clichés. Compensation has to be designed so that companies can
‘recruit, retain and motivate’ their senior staff. Investors increasingly
demand ‘transparency’ in the reporting of executive rewards. In some
countries this is very much against the prevailing culture, and many have
observed that transparency is not the same as illumination, with highly
complex structures being revealed that baffle almost everyone, including the
beneficiaries. 14.
There is little doubt,
however, that executive remuneration has risen at a much faster rate than
average earnings in all the advanced economies. This is true both for base
salaries and the combinations of bonuses and share-related rewards. Studies
in the 15.
We cannot ignore the societal impact of what seem
to be unfair or disproportionate rewards being received. At one extreme there
will be some people to whom any compensation above an arbitrary multiple of
average earnings in an economy is wholly unacceptable. Our suggestions will
not appease them. On the other hand, if the electorate as a whole reacts
against a system that enables people to be remunerated on a basis that seems
unjustifiable to any reasonable mind, then the managerial capitalism that dominates
the world at present may be under threat. Our recommendations are aimed at
fair-minded people of all kinds – managers, investors and electors. ANALYSIS ‘RECRUIT, RETAIN AND MOTIVATE’ 16.
Almost every statement of remuneration policy has
this rubric included in it. While it is clearly true that these are the aims
of any such policy, we have separated the three elements out to see whether a
single structure can satisfy all these aspects. The role of senior managers
of companies, particularly chief executives, is a leadership one. A
successful leader is a relatively rare commodity, and is commensurately
valuable to a company and its shareholders. The cost of failures of
leadership can be very high in terms of loss of shareholder value. A leader
will have the ability to think strategically and evolve strategies and a
vision that gives a business competitive advantage. In addition the leader
will have the influencing skills that carries the
business with them. Part of the role is to judge the point at which the
leader’s own rewards threaten the franchise of the business with its
customers, employees, shareholders or society as a whole. 17.
A further element of HR policy is the development
of the existing internal talent, a more reliable means of identifying future
leaders than external recruitment. Recruitment 18.
The design of a pay package that will attract the
best executives, or, for that matter, the best clerical staff, or new
graduates, is essentially a market matter. If there is a limited cohort of
people qualified to do a particular job, enough needs to be offered to the
candidates to attract them to move from their current post. Although pay is a
clear measure of this market level, it is not the only one. Working
conditions and job security are among the other contributors to the decision
any candidate will make; consultants in 19.
Is there evidence that there is really a global
market in talent? There is some indication that non-nationals have become
more common at the top of companies in many areas of the world. In the 20.
The consultants opine that a base level salary of
between 20 and 25 per cent above their current level is required to tempt
someone away from their current post. The second cliché contained in most
remuneration policy statements is that the target is to pay ‘top quartile’
rewards to its senior executives. Few, if any, companies will pitch basic
salary at median or below. This leads
to what has become known as the ‘Lake Wobegon
Syndrome’. In Garrison Keillor’s portrait of this
fictional mid-Western town, the inhabitants pride themselves that all their
children are above average. Older British voters may recall the government
minister in the 1960s who was reported as seeking to
have everyone paid above average earnings. If no one is prepared to pay below
median base salaries, the leap-frogging of basic
pay that has been a feature of recent years is inevitable. This has been the
unintended consequence of greater transparency. While consultants had
previously been able, through their own experience, to judge the range basic
pay for senior roles, the publication of the information makes every
executive aware of the going rate. Few will be prepared to see their own
salary at a lower level than their peers. McKinsey & Co’s
WFT Studies 2001 included a distribution diagram of companies' ratings of
their own executives. Companies rated 91% of their executives in the top
three quintiles of talent (ranging from ‘Stars’ at 8% to ‘Strugglers’ at only
2%, with 43% being rated as
‘Meeting all Expectations’). This is statistically as unlikely
as the 21.
Because every company will have a slightly
different compensation policy, it would be foolish and of little value for
this committee to suggest what level of base salary (expressed in percentages
of comparable roles) is desirable. All we can do is point out the statistical
consequence of aiming at the median. What we can recommend is that total
remuneration packages reflect the level at which base salaries are set: the
potential total reward for those who are appointed on relatively low base
salaries should be higher than for those whose base salaries (‘non-risk pay’)
are already in the top quartile. 22.
It is the structure of risk pay that creates the
greatest concern. Badly designed, it may give entirely the wrong incentive to
the executive concerned. The third commonplace statement made in remuneration
reports is that the total compensation packages are designed to ‘align
management and shareholder interests’ and it is worth pausing here to
consider whether we can define structures that may achieve this, and others
we can agree are unlikely to do so. The economist Robin Marris
has written that ‘the search for a perfect control contract between
shareholders and managers is inevitably doomed’. While that may be true, the
Committee believes that some universally accepted ground rules would help
move the debate along. 23.
Management interests have often been caricatured
as follows: to make as much money as possible, over as short a time as
possible, and with as little risk. This is unfairly crude as a description,
but exceptions are not plentiful. Only rarely do we see senior executives
refuse rewards (three directors of Pearson, and the CEO of WPP, turned down
bonuses for 2001); many more go cap in hand to their boards to complain how
poorly they are rewarded against their peers. We shall examine below evidence that
compensation is not the only real motivation for senior executives. 24.
There are two further complications. There is some
anecdotal evidence that highly paid executives are refusing to join the
quoted company boards because this would reveal their earnings to the world.
Secondly, there seems a mismatch between the life of most executive schemes
and the life expectancy of executives in their current jobs. Whereas
incentive schemes may last for ten years, the average tenure of a CEO in the 25.
Shareholders interests are more complicated. First
of all, we have to identify which shareholders we are concerned about –
investors at the start of the measurement period may be very different from
those paying the reward at the end of the period. Because a share register
changes rapidly over time, it may be thought that we should take the view
expressed by the economists John Kay and Aubrey Silberstone,
that there is no such thing as ‘long-term shareholder interest’. However,
despite the short average holding period of a company’s shares that is
derived from turnover rates, this includes some holders who trade the same
shares many times in a year, some who trade part of their holdings actively,
and some who deliberately index-track. The average shareholder in a company
has some shares in it for much longer than the crude arithmetic suggests, and
certainly longer, on average, than the measurement period for company at-risk
pay schemes. How does a shareholder judge the success of a company? Over the
very long term, the share price does reflect all the elements that indicate
the health, or otherwise, of a company - profits, dividends, management
strength, long-term prospects. However, as we have seen in the late 1990s,
there are periods of bubble where share prices do not reflect any of these
elements to any sensible extent. Yet many at-risk pay schemes made thousands
of executives rich while the shares in their companies may have made their
investors poor. Perhaps appropriately, it was ‘The Beggar’s Opera’ that ‘made
Gay rich, and Rich gay’, in the aftermath of the South Sea Bubble in the
1720s, since so many brilliant people had been beggared while the directors
had enriched themselves. Most institutional shareholders also prefer to
reward managements for good relative performance against their peers, rather
than simply for participating in a bull market. It is certainly the view of
the Committee that the current normal time-scale for measuring management
success for at-risk pay is inappropriate, at three years. 26.
The greatest correlation in basic pay scales is
between the size of the enterprise and the reward. The following table is
taken from the Arthur Andersen Directors’ Remuneration Report 2001, covering
the FTSE 350 companies in the Market Capitalisation Salary of Top
Full-Time Executives #m # 200-500 278,791 500-1,000 325,501 1,000-2,000 371,105 2,000-4,000 417,933 4,000-8,000 549,842 8,000-16,000 570,843 16,000-32,000 756,368 more than 32,000 797,502 We shall return below to
the question of whether such a correlation create
perverse incentives. The Committee accepts that this is almost an inevitable
feature of remuneration, although it is crude. Some analysts have tried to
measure management jobs through an assessment of complexity, on the basis
that managing a large domestic, regulated utility may require fewer skills
than a medium-sized high-tech multinational. Even if we accept size as a
criterion for base salaries, we than have to define what measure of size
should be used. Market capitalisations may be, as we have seen, ephemeral. In
a world of intellectual property, assets employed may not be the ideal measure.
The number of employees gives some indication as to complexity, as does the
number of separate operational locations. Profits themselves are probably too
volatile and subject to some manipulation to represent a reasonable basis for
fixing base salaries. Revenues seem to be the best proxy for economic impact,
although this does not capture the distinctions between, say, a commodity
business with tiny margins, or a start-up. Without creating another complex
formula, that might not meet all eventualities, it must be for remuneration
committees to make judgements on these matters, but they should not simply
accept the measure that indicates the highest level of base salary. RETENTION 27.
Retaining staff is tied up with the overall
remuneration package, and cannot really be separated from the ‘motivation’
element. Every company will track its staff turnover. The British Post Office
is reputed to see a 40% staff turnover every year; GE in the 28.
Employment contracts do not seem to be effective
retention mechanisms. In the US, UK and other jurisdictions the courts take
exception to contracts that restrict the right of an individual to sell their
services as an employee to whoever they wish, and over-restrictive
non-compete clauses are usually thrown out.
Australian experience suggests that reasonably restricted non-compete
clauses of a year, or even more, are enforceable in law. Any employee who has
determined they wish to leave to join another firm, but is asked to serve out
a long notice clause becomes a risk to their current employer. Disaffection
is contagious, and most people are put on ‘gardening leave’ before being
allowed to take up their new post. 29.
The sacrifice of a potentially rewarding incentive
scheme can provide an incentive for an employee to stay in their current job.
Deferred bonuses are another mechanism by which retention is engineered.
PepsiCo has recently announced a new contract for the Chairman and CEO of
Quaker Oats, (recently acquired), which guarantees him $19.7m simply for
staying in post for at least the next 18 months. It has become a common
feature of senior management moves that the new employer compensates the
executive for any bonuses left behind, and similar or better incentive
packages are offered in the new job. Another recent development in the 30.
Employment contracts became a much-debated element
of pay structures, a debate stimulated by high-profile examples of senior
managers sacked by their boards for underperformance. In many examples, the
remaining length of the employment contract triggered the payment of a
‘golden parachute’ in compensation for the unexpired portion. Long contracts
are much less widespread in the 31.
We are attracted by the idea promulgated by Paul Myners, the author of a report on institutional
investment in the UK, that termination payments for executives (other than
for cause) should be made by reference to the value of the company’s shares
on departure relative to that on appointment. The executive would be
allocated (either notionally or actually) a number of shares equivalent in
value to one year’s salary. Those shares would be the value of the compensation
for loss of office. If the executive had presided over a collapse in the
share price, the compensation would be similarly affected. Where the loss of
office was despite a sharp rise in the share price, compensation would be
substantial. MOTIVATION 32.
This is the area of greatest confusion and
complexity. The first thing to point out is that the form of incentive will
dictate the behaviour of the executive. Investment managers know this very
well. If they are to be measured against a clear benchmark, they know that
their business risk is to depart markedly from the components of that
yardstick. This is true whether or not the client might benefit from such an
approach. If the incentive scheme put in place for an executive depends on
the achievement of beating an earnings per share hurdle over a three-year
period, then all senior management focus will be to achieve that goal. If the
benchmark is set against a peer group, it will be a bold, or highly
self-confident, management that follows a completely different strategy to
its competitors. 33.
As with recruitment, compensation is not the only
motivational factor for executives. In many countries there are
non-compensation elements that are important contributors to executive
satisfaction. In 34. The normal
structure of incentive packages comprises two elements: short-term and
long-term. Short-term bonus payments are usually made in cash, with long-term
elements increasingly being made in shares, either options or restricted
share issues. As a generalisation, short-term bonuses are structured to be
awarded against specific objectives agreed by the board and the executive at
the start of the year. Some of them will be financial, and some will be
non-financial. It is impossible (and probably undesirable) for outsiders to
determine whether these criteria are the most appropriate, and many of the
decisions are subjective, rather than objective. They are seen as a way of
indicating to the executive the board’s view of the executive’s performance
during the year, and, as such, are both aimed at retention and motivation.
Sometimes the decisions are a way for the board to indicate to the executive
that they are underperforming, as a step on the road to dismissal. Since base
salaries are, as we have seen in paragraph 26, correlated with the size of
companies, there is an implicit incentive for executives to seek to increase
the size of their companies through bids and mergers. Even more insidious is
that large short-term cash bonuses have been awarded on the completion of
substantial corporate transactions. The rationale has been that executives
will have worked beyond the call of duty to execute a ‘transforming deal’. Set
aside for the moment the evidence that over 50% of acquisitions destroy
shareholder value for the buyer, we question whether such bonuses are not
offering perverse incentives. It may seem much more rewarding and enjoyable
to participate in a very public bid for another company rather than to manage
what is already owned. The outcome of such bids and mergers is often not
apparent for many years. If these truly are ‘transforming deals’ that fact
will emerge over time, and executives should certainly be rewarded for their
strategic insight. It is not a reason for instant gratification. The
Committee is opposed to cash transaction bonuses. 35. What level is
set for these short-term bonuses? There seems to have been an increase in the
target set for short-term/annual bonus possibilities. A paper by Conyon,
Peck, Read and Sadler (The Structure of Executive Compensation Contracts: UK
Evidence) published in Long Range Planning 33, shows a mean distribution of
CEO compensation in 1997 of 54% salary, 24% short-term bonus and 22% non-cash
long-term incentive plans or options. The paper also shows that the total
cash pay of CEOs rose by 22% over the previous
year. 36. It is the
structure of long-term at-risk pay that causes most of the friction between
company boards and their shareholders. Most of these are share-based in some
way, either options or restricted shares. Some have hurdles imposed on their
award, others, notably in the 37. The lie to the
idea that options always align the shareholder and the executive comes
particularly in the plea that seriously out-of-the-money options should be repriced. There is no arguing that holding such options
may seriously demotivate executives, knowing that
they could work for years without achieving any long-term benefits. However,
there is an implicit assumption that a rise in share price is somehow all due
to the superior skills of the executives, whereas a fall is a consequence of
a malign external influence. Perhaps some of the executives who are
complaining that their shares are trading well below the exercise price of
their options were part of the problem, and shareholders might be happy for
them to be so demotivated as to leave without
costing them any more. 38. Part of the
problem is that options are often awarded in one large block, rather than on
an annual basis. Because stock markets can suffer from irrational exuberance,
it makes little sense to make large one-off grants. Regular grants will
ensure ‘dollar cost averaging’ and will more accurately replicate the
experience of the average shareholder. 39. There is little
consistency around the world in reporting the worth of share option grants.
Too often, the value of the shares at the strike price is the only figure
mentioned. There is plenty of experience of valuing options, but, in most
cases, the life of the option is measured in months, or three years at most,
whereas executive options can have a life of ten years. 40. In many cases,
there are no conditions attached to the vesting of options granted to
executives except one of timing. This seems to run counter to the argument
that these are rewards for management success, rather than simply for a bull
market. Other problems with options have arisen. If conditions are attached to
the grants, often they are not published at the outset, and remain at the
discretion of the remuneration committees or boards. The phenomenon of ‘re-testing’ has also become a feature of many grants.
If vesting is conditional on meeting some profits or relative share price
performance hurdle, this event can be postponed from year to year, increasing
significantly the possibility of meeting the benchmark. All these features
reduce the risk element in the granting of options. This has led many to
question whether such awards do not have many of the features of guaranteed
long-term bonuses. 41. The other
method of reward, which has had a vogue in the 42. As can be
understood, long-term incentive schemes have become very sophisticated and
complicated. Advisers have been quick to exploit the gaps and inconsistencies
in institutional remuneration policies. This is the first obvious area of
conflict between the executives and the shareholders. The executives say that
they wish to have a clear, easily understood scheme, by which they can
measure, on a daily basis if necessary, the wealth they are earning.
Investors, on the other hand, are trying to reward real management skill,
which is much less straightforwardly a matter of the share price. Investors
want to reward good managements in difficult industries and in bear markets.
Plain share options do not do this. Perhaps the problem stems from the fact
that the measurement of investment management performance is almost always a
matter of relative success, rather than simply an absolute return. This has
changed over the past few years of declining share prices, with absolute
return funds gaining adherents, but it is still true for the bulk of the
institutionally managed funds. Our conclusion is that share options will
probably continue to be an important constituent of long-term incentive
schemes, however imperfect they are, since they are highly valued by
executives. However, we believe that awards should be regular, with
performance hurdles that are not subject to too much discretion from
Remuneration Committees after their issue, and that they should not be the
only long-term incentive. The total package should contain several different
elements. Although this sacrifices simplicity, it may be more effective in
meeting all eventualities and in aligning shareholder and management
interests. 43. The question
that has not yet been asked is how large these rewards should be. The danger
of getting this wrong could cost a company more than the reward to the
executives. We have seen several instances where the disclosure of the
compensation packages of Chief Executives has had serious effects on the
perception of a company by its customers, staff and shareholders, sometimes
with long-term consequences, even to the continued existence of the company
being threatened. Reputational risk is high on the
agenda for all boards, in many areas. The potential damage to a company of
misjudgement on rewards can be as great as an environmental scandal, and
remuneration committees must treat this risk seriously. The recent
revelations about Enron, where senior directors seem to have been
participants in Special Purpose Vehicles where they could benefit even if the
company as whole did not, illustrates the dangers of
such rewards. The Committee strongly believes such structures are entirely
inappropriate. There has been a move towards what Frank and Cook (1995) have
described as The Winner-Take-All
Society ( 44. It is always
difficult for an outsider to analyse with any precision what levels of
remuneration in a company should be. The observer can only react, with the
benefit of hindsight, when a board has made an error of judgement. Investors
(and the press) should be sophisticated enough to understand when rewards are
earned and when they are disproportionate, and it would certainly help if
institutional investors applauded high figures truly earned by the executive
concerned. Some institutions have begun to suggest ratios of reward
structures, between base salary, short- and
long-term rewards. These ignore all the non-pay benefits that are
characteristic of some markets, but do give a guide to what might be
acceptable. One suggestion (by Tony Watson, CEO of UK investment manager
Hermes Pensions Management) is that a ratio of 1:1:2-4 might be acceptable
for exceptional performance. The policy of GlaxoSmithKline,
in its briefing document ‘Performance with Integrity’ suggests, as an illustration,
a ratio of 1:1:1.25 for ‘above target’ performance, or 1:0.5:1 for ‘on
target’ performance. The first formula
suggests that a consistent top decile manager might
expect in total to receive annually between four and six times the notional
basic pay. An average performer might receive a total of no more than twice
basic salary. An underperformer might not receive anything but the base
income. In large companies, these would be very substantial sums for the
successful executive, but might still be proportionate to the responsibility
and value added. What all investors find difficult to countenance are
disproportionate rewards for a single person. It is impossible to believe
that any individual is worth hundreds of millions of dollars a year. Despite
the ‘Winner-take-all’ theory, such payments may, if taken to extremes,
undermine the morale and pay structures of the ‘marzipan’ layer of
executives, or create such competition for the top job, the only one with
excessive compensation, so that succession politics, rather than business
management, is the order of the day. It is a matter of judgement again
whether there should be a cap to the possible rewards to an executive. In
designing these schemes, too little work has been done on possible outcomes. DESIGN AND CONTROL 45.
It is boards of companies that must continue to
take responsibility for the design and control of executive compensation
schemes. This task is often delegated to a remuneration committee, and these,
in turn, make use of external consultants in the design of structures. 46.
The first thing to determine is who should sit on
whatever body is responsible for designing and recommending compensation
structures. It is difficult to believe that anyone can seriously defend those
who will benefit from a compensation scheme being party to its approval. On
the other hand, it would be odd if a CEO was not involved in the design of
senior executive remuneration structures at all. The sensible and pragmatic
solution is for the CEO to participate in discussions about the company-wide structure,
but for no executive to be a voting member of whatever committee approves the
results. There is room for argument about whether a company Chairman should
be involved. Chairmen who are full time employees are clearly disqualified in
the same way from serving on the decisive committee. Unlike other external
directors, an effective Chairman should not be truly non-executive, the job
being to manage the board, monitor and mentor the Chief Executive, and to be
a public voice and representative of the company. Consequently a Chairman
will typically be much more involved and quasi-executive, and that could make
it difficult for the person taking that role to be wholly independent of the
executive. 47.
It is the clear independence of those making the
decisions about compensation structures upon which the outside shareholders
depend. All outside directors believe themselves to be resolutely
independent, even if, or perhaps because, they were previously executives of
the company, or professional advisers to it, or are related to the
executives, or have the executive of the company on their own boards. While
such contacts do not disqualify a director from serving on a board, it would
be better not to have these apparent possible conflicts of interest
intervening in discussion about executive pay. 48.
The committee or board that determines
compensation structures will clearly need to have input and advice from
professionals in the field. One question is to whom these consultants should
report. Conyon, Peck, Read and Sadler (op cit)
found that ‘Remuneration committee proposals to the main board about pay
levels and structures are based on information received from the company’s
human resource department. The information collected by the company is done
in conjunction with advice from professional advisers outside the company…..
In consequence, the remuneration committee does not usually hire its own
separate advisers, or influence its terms of reference.’ If a consultancy
firm does a large volume of business with the company, and is appointed to
those tasks by the executive, is there a danger that the advice given to the
independent committee of directors is contaminated in some way? Would it be
better to have a separate consultancy advising the remuneration committee,
which would be forbidden to do other work for the company? In these cases,
the consultants would be appointed by, and be responsible to the committee
itself, and clearly not to the executive. We conclude that, although the
appointment of remuneration consultants should usually be jointly agreed
between the Remuneration Committee and the executives, the Remuneration
Committee should have a veto over appointments and the terms of those
appointments. 49.
While the number of pages devoted to remuneration
matters in annual reports has expanded dramatically, this has been at the
expense of clarity and simplicity. The investing institutions do not
generally spend much resource in analysing these reports. The reason for this
is clear – their clients do not pay them more for such work, and it is highly
labour intensive. There are external services doing the work, and some
industry bodies, but remuneration structures are things of immense subtlety,
and, to use another cliché familiar in this field, the devil is in the
detail. It has been very difficult to encourage the institutions to work
together in this area. For instance, in the 50.
If the body designing compensation packages simply
states its policy as being designed to ‘recruit, retain and motivate’ and to
offer the ‘prospect of top quartile compensation’, the shareholder is in the
dark. It has been suggested that the committee or the board itself should
have explicit, written mandates that should be published. SHAREHOLDER MONITORING 51.
Although there has been an increase in the amount
of time and effort given to monitoring executive compensation packages among
many institutions, it has been very patchy. In the 52.
For shareholders to exercise their stewardship
role, either directly or indirectly, requires a level of disclosure. While,
as we have noted, this has sometimes become overwhelming, with disclosure and
complexity obscuring, rather than enhancing, transparency, it might be
sensible to agree some basic levels of disclosure in the annual report, with
greater detail being available either on-line, or in supplementary documents
such as 10-Ks. What should such a statement contain? The first need is for
the board, or its remuneration committee, to disclose what its policies are
(as suggested in paragraph40 above). The second requirement is to disclose
all the benefits, both monetary and non-monetary, that have been paid to
executives in the period under review. Complex questions about, say, the
value of pension enhancements are involved here, but need to be disclosed.
This may prove a difficult break from the traditional secrecy about pay that
is so prevalent in some countries. The need for such disclosure is that trust
between the investor and boards has broken down on this matter. It is of
great moment that Deutsche Bank is to disclose executive remuneration in its
2003 Annual Report. Despite these difficulties and possible unintended
consequences, the Committee believes that full reporting of remuneration is a
necessary prerequisite for any sensible discussion of this subject. 53.
The third basic requirement is that proposed new
compensation structures should be analysed for possible outcomes. This should
clearly be done by the company’s board anyway, but a brief outline of the
conclusions would prepare shareholders for payments to be made in three or
more year’s time, and might neutralise comment when they are actually due. 54.
Fourthly, it seems desirable to give shareholders
the opportunity to vote specifically on remuneration on a regular, annual,
basis. There are those who believe that such a vote is both nugatory, in that
it could not undo contracts already undertaken, and intrudes into the
boardroom in an unprecedented way. However, the contrary view is that, since
this is uniquely an area in which the board has control over the direct
transfer of the shareholders’ wealth to its own members, a register of
shareholder opinion is both desirable and necessary. Such a vote would give
legitimacy to the outcomes of compensation structures, and act as a lightning
rod for concern about this single element of company policy. If these
resolutions are to be put to shareholders, it will require much greater
analysis and involvement of the investing institutions. Their public support,
where earned, will be critical in changing the climate of the debate on this
subject. It may make the management of AGMs more susceptible to disruption
for single-issue protestors, but they already have opportunities to draw
attention to themselves and their causes in debate on other resolutions. We
believe such a vote would give shareholders a clearer opportunity to support
sensible remuneration structures publicly. Costard: “Remuneration! O, that’s the Latin word for three farthings: three farthings – remuneration. – ‘What’s the price of this inkle?’ – ‘A Penny.’ – ‘No, I’ll give you a remuneration’: why, it carries it. – Remuneration! – why, it is a fairer name than French crown. I will never buy and sell out of this word.” William Shakespeare: Love’s Labour’s Lost, Act III Scene 1 THE ICGN SUB-COMMITTEE ON EXECUTIVE REMUNERATION Alastair Ross Goobey, ( Linda Selbach,
( Ariyoshi Okumura, ( Florian Schilling, ( Rob Collinge, ( Sandy Easterbrook, ( Colin Melvin, ( Secretary: David Snell, (Hermes Pensions Management) |