I have been a member of remuneration committees - or compensation committees, as they tend to be called in the US - for more than 20 years, for organisations both large and small across both private and public sectors. Some of the most heated and contentious boardroom discussions I have ever witnessed have taken place when 'remco' members try to reach agreement over the controversial matter of CEO pay. Issues such as what metrics to use to measure long-term company performance or the weighting to be given to different KPIs may sound dull but can produce a lot of emotional intensity and anger.
This has been a particularly trying year for compensation committees in the US as the Dodd-Franks 'say on pay' rules come into force, giving shareholders greater powers to vote down remuneration packages. A new emphasis on transparency and clear process in setting pay at the top has been forced on boards, as the proxy statements sent out by US companies to investors before annual meetings now require greater disclosure on executive remuneration. Already, it seems, some Fortune 500 companies have cut the pay and benefits of top executives rather than face adverse scrutiny from shareholders.
Discomfort with the ineluctable upward spiral in senior executive pay and an ever-widening gap between those at the top and the average employee have prompted the European commissioner for internal market and services, Michel Barnier, to issue a green paper earlier this year proposing that companies in the 27 member states put their remuneration policies to the vote by shareholders and also that the disclosure of top executive pay be mandatory.
This will be nothing new to British companies, as they have been subject to a statutory obligation to hold a vote on directors' pay at the AGM and to publish a remuneration report since 2006. Even before this, shareholders did not hesitate to make their feelings clear to boards if they were unhappy about executive pay. In 2003, the pharmaceutical giant GlaxoSmithKline became the first company to receive a very public mauling when its shareholders voted down its proposals for the CEO's pay, leading eventually to board departures. Nowadays, most companies take the precaution of running their remuneration plans by their major shareholders well in advance to avoid such public humiliation. This way, objections can be registered, changes made quietly behind the scenes and the AGM vote then becomes a mere formality.
While it has long been accepted that audit committees should consist of suitably skilled people and have a financially qualified chairman, directors have, in the past, often been appointed to compensation committees not on the basis of distinctive expertise and experience but because they could be relied on to be sympathetic to management over compensation issues. This is very much not the case in today's company.
Compensation committees have been described as needing to be at the cutting edge of board independence because of their role in setting management pay. Interestingly, the criteria for independence are much stricter in the UK than in the US. Under the UK corporate governance code, a director who has been on a company board for more than nine years is no longer deemed independent, while, in the US, directors frequently serve for much longer than this and it is often these senior board members who are appointed to compensation committees. This is no reflection on the integrity and independence of individual directors but rather an indication of different corporate governance standards.
While transparency is generally regarded as a good thing, some commentators have argued that there is a direct link between pay excesses and disclosure. This arises not only because it makes competition between CEOs of the 'my bonus is bigger than yours' variety easier, but also as a result of benchmarking by remuneration consultants. The benchmarking studies use information about CEO pay disclosed in annual reports to develop tables that divide comparable companies into low, median and high quartiles. Since no company wants to be accused of recruiting a CEO not worth at least the median, an inevitable upward pay trend results. However, it is worth noting that some CEOs are not particularly motivated by money and give up awards they are granted because they are not satisfied with their own performance or think a pay hike will send out the wrong message. It must be said, such CEOs are rarely found in banking.
Nevertheless, disclosure requirements place a need for great rigour on compensation committees, comparable to that required of audit committees. Agendas need to be agreed well in advance; timetables for meetings set and full minutes taken and, while management should be available to consult with the committee, they should not routinely be present at its deliberations. Members also need to be given enough time to review documentation so that in the meeting they can concentrate on deciding issues rather than absorbing information. These may sound like obvious measures but, surprisingly, they are not always implemented, especially in smaller companies without an experienced company secretariat. Getting these basic things right can lower the temperature in the boardroom and ensure better decision-making.
As many British remco chairmen can tell their US counterparts, it is no fun being in the firing line at an AGM when the remuneration report comes under adverse scrutiny.
- Baroness Kingsmill is currently a non-executive director of British, European and US boards. Lady Kingsmill can be contacted on firstname.lastname@example.org.