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Making better remuneration decisions

21 October 2014   (0 Comments)
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Acting in the best interest of the company is central to enabling remuneration committees (Remco) to make better decisions. That’s according to the Remuneration Committee Forum, a forum of the Institute of Directors in Southern Africa (IoDSA), sponsored by EY in its latest position paper* on Managing Conflicts and Tensions in the remuneration committee.

According to forum chair, EY’s Ray Harraway, "Doing what will best serve the interests of the company on whose board you’re serving is perhaps the most important principle when it comes to making better remuneration decisions. This ‘golden rule’ also lies at the heart of three key factors which, when present in remuneration committees, enable them to make quality remuneration decisions.

Three factors that contribute towards effective remuneration committees

Composition of the remuneration committee

Remuneration committees can only truly be regarded as effective if they are composed of independent directors who are tasked with implementing an effective mandate.

"Such a committee would ideally be composed of at least three non-executive directors, a majority of whom should be the independent non-executive directors,” says Harraway. "This composition enables the committee to more easily operate independently from management and is, I believe, the most effective way to reduce and manage conflicts of interest and tensions within the committee.”

Beyond this, he says independent directors need to have the guts and integrity to challenge the views of management. "However, this requires the directors to have a comprehensive understanding of the business, as well as the skills needed to assess the fairness of, for example, the performance measures used in bonus targets.”

Engaged shareholders

Another factor in arriving at quality remuneration decisions is a plan that promotes effective engagement with shareholders. "Although such a plan is different for each company, it must drive transparency, disclosure and effective relationships, without which it will be impossible to make good decisions.”

Remuneration system

Thirdly, the information that helps shape remuneration decisions is only as good as the remuneration system that such information is drawn from. "If, for example, the job evaluation process or the strategy to manage reward is flawed in some way, the result will not be satisfactory, no matter how diligently the Remco members apply their policies. Each decision needs to be weighed considering whether or not it is in the best interests of the company.”

Tensions within remuneration committees

Non-executive fees

One of the major tensions within remuneration committees that the paper focuses on is the question of the remuneration committee members being inherently conflicted when determining non-executive director fees. One of the recommendations made is that the executive directors be involved in determining the fees, rather than simply depending on benchmark information on fees. "This is a good strategy since it removes to a great extent the question of conflict of interest,” says Harraway.

Measuring company performance

Another area where tension often arises is where bonus targets are set based on internal measures of company performance. "Where a bonus plan hinges on profit targets, a weak Remco, without the right skills or information, will not be able to effectively challenge the numbers, and the required stretch in the targets,” he says.

"It comes down to the business acumen of the individual members, which explains why Remco members are beginning to see their fees increase - even coming in line with audit committees fees.”

Representative Directors

Another difficult area concerns representative directors in a group situation. "Much difficulty may result when it comes to the exchange of information,” he says. "Here, King III advises drawing up a governance framework with some good legal advice – yet nothing is a substitute for prevailing upon Remco members to act with integrity, in the best interests of the company, regardless of who has appointed them to the board.”

As a good steward of the company, the paper concludes that it’s up to each member of the remuneration committee to discharge the following moral duties: conscience (acting in the best interest of the company, avoiding conflicts of interest); inclusivity (taking into account the legitimate interests of stakeholders); competence (a director needs to ensure he has the knowledge and skills needed to play his role effectively); commitment and courage to act with integrity.

*The paper provides practical guidance on managing specific conflicts of interest and tensions that arise at the remuneration committee. (Available at www.iodsa.co.za/resources, it should be read together with the King III Code and Report on Corporate Governance and its related Practice notes.)

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