Remuneration Committees Must Consider Overall Corporate Pay Structure, Not Just Executive Pay

REMUNERATION COMMITTEES MUST CONSIDER OVERALL CORPORATE PAY STRUCTURE, NOT JUST EXECUTIVE PAY

Wage levels, and particularly disparities between executive and worker pay, is always an emotive question. The Institute of Directors in Southern Africa (IoDSA)’s Remuneration Committee Forum believes that remuneration committees must work hard to take an objective view, and try to avoid an emotive response.

Ray Harraway, who leads the IoDSA’s Remuneration Committee Forum and is also a director at EY, points out that there are updated remuneration guidelines for remuneration committees in the King III practice notes.

"Too often, companies tend to lapse into conformity around pay issues too quickly. This is a complex issue, and remuneration committees have to use common sense, innovation, and a long-term view to come up with the right solution for their company,” Harraway says. "An unintended consequence of the move towards transparency is that the nuances of each company’s position tend to get lost as companies’ pay rates are compared as though everything else is equal. This is simply not the case.”

He cites the attempt in Europe to cap bonuses as a percentage of annual salary as a move that is likely to have adverse consequences—one of which will be a tendency for annual salaries to rise. The same point could be made of the current trend to adopt a "pay ratio” (the measure of the gap between top and bottom wage-earners in a company) as a way to understand the disparity. In this instance, Harraway argues, the trick will be to resist the temptation to compare company with company, no matter how tempting. Each company has its own distinct strategies, business and talent management models and organisational structures, which in turn will determine its unique remuneration models.

Another unintended consequence of transparency has been to raise executive pay, as executives demand parity with their peers in other companies—a trend that is spreading to wage-earners now. Again, this approach ignores the substantial differences between companies and their strategies.

"The main point is surely that pay, variable pay in particular, must be aligned with the company’s performance,” Harraway argues. "What’s problematic is that companies and their broader stakeholders seldom have a clear, shared understanding of what they mean by performance, and thus what the key performance indicators should be.”

The setting of key performance indicators, always complex, has become more so with the advent of integrated reporting. Companies and their remuneration committees thus need to give serious and sustained thought to how to strike a balance between the two poles of near-term financial gain and long-term sustainability. (It should never be forgotten, however, that sustainability also includes the company’s financial viability over the long term.)

One of the delicate balances they must strike is between the need to incentivise top executives who are desperately needed to navigate the rapids of an extremely challenging global economy, and the need to support labour stability.

"In a country like South Africa, at least, we do need to acknowledge that the differential between top and bottom earners has to be reduced, not widened,” Harraway says. "But paying executives less—the kneejerk reaction—seems to be a no-win approach that uses a plaster to stem an arterial bleed. Remuneration committees have to take the lead in coming up with solutions that address the problem without affecting the company’s ability to attract top talent, and so dampen its prospects. In fact, I personally believe that remuneration committees need to concern themselves not just with executive pay, but with the pay of all job levels.”

Harraway believes that it is a good sign that some executives are beginning to voluntarily forfeit their bonuses in solidarity with their employees, and calls for remuneration committees to take the lead in this area.

It’s worrying that there are signs that regulators could be considering getting involved, the IoDSA and Harraway believe. The recent Banks Amendment Bill, for example, includes a clause requiring shareholder consultation on the remuneration policy. King III already calls for a shareholder vote on the remuneration policy.

"Regulation of pay would be a step backwards. Remuneration committees have to grasp the nettle and demonstrate that they can use the guidance of codes like King III to exercise independent judgement on executive pay, and perhaps pay across the whole company as well. This is an explosive issue, and it’s one that will not go away,” Harraway concludes.