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A Challenging Time for Remuneration Committees with Executive Pay

Author: Anjie Cai Anderson

The UK Corporate Governance Code (2012) emphasised the level of executive remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully without paying more than is necessary for this purpose. The capability to understand, develop and review executive compensation packages and the effectiveness of communicating with various stakeholders are building blocks of achieving this goal.

Before starting to design executives’ pay, members of the remuneration committee should have adequate financial knowledge, good understanding of the company and its business model and insights into the company’s industry. Assimilating this information can be incredibly demanding for new committee members and extensive support from other members and CHROs is critical. Committee members should have the financial acumen to judge the soundness of compensation packages and recognise any warning signs which may occur. The knowledge of motivation mechanisms will also provide insights into what motives people and how financial awards fit into this mix.

The committee should be updated with financial and governance knowledge as well as the changing landscape of executive remuneration, including regulations, guidelines and new areas of employment contract law. For committee members with various commitments and priorities, it takes efforts to recognise ongoing knowledge requirements and remain adequately informed to be effective within the committee.

Remuneration committees should design and develop appropriate compensation plans based on company strategies. Generally, remuneration committees use peer benchmarks as reference points to design their own pay packages. The practice of benchmarking should consider performance differences between the company and its peers and ensure compensation is designed explicitly with the company in mind. With the pressure of rising executive pay, it is vital to recognise that benchmarks are only one source of information about the appropriate level of compensation and not the primary driver of the right level of compensation.

Remuneration committees are responsible for determining executive performance measures, consisting of financial, strategic and operational metrics. Committees should examine and select the metrics that are most closely tied to a companies’ sustainable growth. Committees should be aware of the potential advantages, disadvantages, and risks associated with various metrics and take these factors into account when selecting metrics and when choosing the the correct ones for the design of compensation programs.

Remuneration committees are also responsible for building an appropriate compensation mix, linking it to a good and appropriate balance of short- and long-term success measurements. If a company’s compensation plan only encourages executives to pursue short-term interests, it will damage shareholders’ interests. According to research, the most common short-term incentive performance metrics between May 1,2014 and April 30, 2015 are some form of earnings or income-related metric (e.g. earnings, profits, net income, pre-tax net income, operating income, EBITDA or earnings per share) (Here). The most common long-term incentive performance metrics are relative total shareholder return (Relative TSR), earnings per share, revenue or return on investment. For smaller companies this poses challenging questions about how to set appropriate and achievable long-term goals.

Advanced-HR and PwC conducted a 2014 Venture Capital Executive Compensation Survey based on 177 private and venture backed life sciences companies in the US (Here). According to the survey, the compensation mix varies by stages of development. It is crucial for the committee to be fully aware of the company growth trajectory and to adjust compensation plan accordingly.

Founder CEO 2014 Median Equity Compensation By Stage of Development (% Fully Diluted Shares)
# CEOs Total Equity Held
Total Companies in Analysis 53 10.56%
Pre-Revenue: All Companies 26 12.77%
Post Series A, No Revenue 10 6.01%
Post Series B, No Revenue 2 10.90%
Revenue: All Companies 27 8.76%
Shipping Product 17 8.76%
Profitable 3 12.41%

Source: 2014 Venture Capital Executive Compensation Survey by Advanced-HR and PwC.

For the remuneration committee to deliver effective governance, the frequency and scheduling of regular meetings must be followed. However, it is commonly reported that many remuneration committees do not adhere to a rigorous timetable. Compensation is highly dynamic and can be effected by a range of external factors. While these factors can equally affect other companies deemed competitive and with which much of the benchmarking has been tied, this is not always the case and so regular review of compensation is paramount.

External resources should be introduced when remuneration committees feel the need to get extra help regarding executive compensation design, legal requirements, tax, and regulatory requirements. Remuneration committees have the responsibility of engaging and monitoring external compensation consultants. Compensation consultants should report directly to the remuneration committee and be reviewed on a regular basis.

In recent years, the debate over CEO pay has intensified. Facing the public scrutiny, a remuneration committee should improve its role of communicating effectively with shareholders about executive compensation. The committee should work with the board to improve executive compensation disclosure by giving accurate and clear information in an easily understood language.

Meanwhile, remuneration committees themselves are facing the challenges of the shortage of qualified candidates. Sitting senior executives are the main population for board members. The increasing workload and responsibilities of their day jobs, plus fear of ‘over-boarding’, make executives less likely or less willing to take on board roles.  Therefore, there is a small pool of qualified remuneration committee candidates with sufficient knowledge and experience.

The role and responsibilities discharged by the board’s remuneration committee grow ever more complex with factors like international executive mobility and cross-border recruiting, thereby increasing the challenges they face, demands which are in fact driving board fees up for remuneration committee membership.

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