The accountability of the remuneration committee and the regulation and shareholder scrutiny of remuneration matters have been increasing in recent years. Has the role of the remuneration committee become as onerous, if not more so, than that of the audit committee?
One consideration that may affect a response to the above query is whether an organisation has separated the challenging and involved work of risk and compliance from the audit committee into a committee of its own.
Where this is the case, the audit committee is left primarily with the (still difficult) duty of challenging and reviewing the organisation’s financial accounts and supervising the organisation’s internal audit function.
In such situations, Directors serving on remuneration committees may experience a heavier burden than those serving on an audit committee due to the following considerations:
- Remuneration advice now comes from three separate sources
The remuneration committee must consider various and at times conflicting sources of information including advice from lawyers, accountants and remuneration consultants.
- Lawyers look at remuneration from a compliance perspective – do policies, contracts and incentive plans meet legal requirements? Do they contain the correct clauses for the company’s situation? Is the company meeting its disclosure and shareholder approval obligations?
- Accountants consider the effect on the profit and loss statement of remuneration and advise on the tax implications of different remuneration options.
- Remuneration consultants consider what quantum and form remuneration should take in order to best reward and retain employees to drive long-term stakeholder value.
Without being incorrect, the advice may at times be at odds due to the different starting point for analyses chosen to fit the motivations of the source.
The remuneration committee must understand the differences and integrate the advice into a meaningful remuneration strategy that best meets the organisation’s situation.
- Directors serving on multiple Boards have a collection of remuneration precedents
Directors may sit on as many as five Boards and will be familiar with the remuneration practices in each of those companies. These varying practices will be referenced in any discussion, at times leading to disagreements. For example, a Director may be sitting on Boards of companies that use fair value for the allocation of equity instruments while another may only sit on Boards of companies that use face value. Some Directors may be familiar with selecting a small per sample of companies for benchmarking, while others have experience with the use of a broad church. Some Directors may prefer to task management with providing information for benchmarking, while others will be used to having the Board source and direct the provision of that information.
- Directors are setting policies and reviewing them
The remuneration committee is accountable for the creation and review of remuneration policies, rather than purely reviewing them. It is the Board, not management or an auditor, that “carries the can” for directions taken.
- There is often conflict between shareholders and the Board on a number of remuneration issues.
A recent US survey by Heidrick and Struggles and Stanford University has highlighted this issue. It surveyed 107 CEOs and Directors of Fortune 500 companies to uncover perceptions of CEO pay practices. Based on expected value of pay at the time of grant, 76% of CEOs and directors surveyed believed CEOs were paid correctly. Based on realised pay, this fell to 65%. In comparison, another Stanford University study released at the same time found that only 16% of the US public surveyed believed CEOs were paid correctly. Although shareholders will generally be savvier on remuneration matters than the general public, the surveys do provide illustration of the problematic dichotomy.
In Egan Associates’ view, one particularly problematic area in Australia where there is a difference of opinion between shareholders and the Board is retention payments. This is often overcome with clear and transparent disclosure of the organisational setting which led to the initiative.
- Setting performance hurdle parameters and weighting requires significant research
Choosing the correct performance conditions and their relative importance requires a firm grasp of the company’s core mission and strategy as well as the accounting knowledge to grasp the benefits and pitfalls of each condition and how they will work in practice.
Setting the parameters for each performance condition requires engagement with the business, analysis of the probability of targets being met and an understanding of peer group practices. It is also necessary to understand market analyst expectations of the organisation, as institutional shareholders and proxy advisors will often reference these when considering the appropriateness of performance hurdles.
- Disclosing and defending the remuneration framework takes time to do correctly
In the words of AMP Capital in its 2015 annual report:
“Executive pay is inevitably one of the most controversial aspects of the proxy voting season.”
The topic not only gains attention from proxy advisors and institutional shareholders, but also mainstream media outlets.
The first step in avoiding controversy is ensuring the remuneration framework is correctly communicated via the annual report. Directors must aim for concise, clear disclosure that demonstrates to stakeholders the framework is fair, reasonable and aligned with shareholder interests.
This is not only important for managing the vote on the remuneration report, but also for ensuring there is a clear record of what is expected of management to receive performance pay, in case later disagreements arise. For this reason, it is important that remuneration committees carefully proof all sections of the remuneration report themselves.
The second step is managing the response from stakeholders to the disclosed remuneration framework. Different parties will hold varying opinions on the correct remuneration for the organisation’s situation. The remuneration committee and especially the Chairman will spend time liaising with key institutional shareholders and proxy advisors to defend and discuss the remuneration framework.
- Exercising discretion opens the Board to potential criticism
No remuneration framework can achieve the correct level of remuneration for every outcome. Where unintended outcomes occur, discretion may need to be exercised. Shareholders will generally accept reasoned discretion, but can be critical of discretion that is not well reasoned or disclosed. Directors must engage with shareholders to understand their views, as well as communicate clearly with executives to ensure they are not surprised by discretionary changes to awards.
Egan Associates recently completed some research on example situations where discretion may be required, which you can access here.
- The role of the remuneration committee has expanded
Many remuneration committees have expanded their duties to include a nomination and broader HR function, where the committee will be accountable for succession planning and people management. This may lead to a deep involvement in the areas of company culture, gender pay, diversity as well as training and development. When becoming involved in these areas, remuneration committees must be cautious to be a helpful advisor to management without directing management.
One method of testing the hypothesis that the duties of the remuneration committee have become at least as onerous if not more so than those of the audit committee is to examine the number of meetings recorded by companies for each committee.
The average and median number of remuneration and audit committee meetings for the latest disclosures among top Australian companies where the companies have been ranked based on market capitalisation as at 31 December 2015 can be found below:
In terms of number of meetings, for Australia’s top 100 companies, and top 200 if only the median is considered, the remuneration committee appears to be as onerous as the audit committee. However, this does not remain the case for smaller companies. This may be a function of reduced scrutiny of remuneration while the audit requirements remain the same.
In the broad audit committee definition, the categories of audit and risk management; audit and compliance; audit, risk management and compliance; and standalone audit committees have been considered. In the remuneration committee definition, the categories of human resources; nomination and remuneration; and standalone remuneration committees have been considered.
Egan Associates would note that the number of meetings a Committee holds does not necessarily equate to the amount of preparation time involved in meeting their obligations. In our view, where audit and risk functions are combined into one committee, this will be the most onerous committee. However, where the audit committee is standalone, the factors listed above lead to the work of the remuneration committee (particularly where it incorporates a broader organisational brief) becoming as onerous, if not more onerous, than that of the audit committee. This is particularly the case for the Chairman of the committee.