Director Remuneration in the UK - Essay Example

?Director Remuneration: Case Study In many jurisdictions including UK, public limited companies are required to establish a remuneration committeein order to deal with executive directors’ remuneration. The remuneration committee is a ‘sub-committee of board of directors’ (Bender & Porter 2003). The remuneration committee members and remuneration consultants are the key players in the remuneration-setting arena (ibid). As Collier and Agyei-Ampomah (2009, p. 90) point out, the remuneration committee has the function to ensure that remuneration arrangements are in line with the company’s strategic aims and facilitate recruitment, motivation, and retention of executive directors. The committee must also make sure that remuneration arrangements strictly abide by the regulatory bodies’ requirements and meet the expectations of shareholders as well as the wider employee population (ibid). Earlier, controversial director remuneration increases in the United Kingdom were widely criticised and as a result, the UK government framed a set of regulations to control executive director remuneration. According to the Code of Best Practice suggested by the Greenbury committee, the remuneration committee must be comprised of non executive directors. The Greenbury committee also directs to completely disclose the remuneration policy as well as directors’ individual remuneration package. The UK Corporate Governance Code 2010 or simply the Code, which is a set of some good corporate principles, describes various procedures involved in setting executive director remuneration in public limited companies. Section D.1 of the UK Corporate Governance Code 2010 states that the level of remuneration should be sufficient enough to attract, motivate, and retain executive directors and thereby run the company successfully. At the same time, the level of executive remuneration must not be more than necessary. The section D.1 specifically says that “a significant proportion of executive directors’ remuneration should be structured so as to link rewards to corporate and individual performance” (The UK Corporate Governance Code, 2010). The Code continues that elements of performance-based executive remuneration must focus on the company’s long term success. In addition, the remuneration committee has to decide whether to structure their remuneration policy relative to other companies; however, the committee must consider the risk of higher levels of remuneration with no corresponding performance improvement. The committee should also consider pay and employment conditions while making decisions on annual salary increases. The Section D.2 deals with procedures involved in setting executive directors’ remuneration. According to this section, “there should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors” (The UK corporate governance code (The UK Corporate Governance Code, 2010). Referring to Main principles of the UK corporate governance code (genius methods, 2010) section D.2 clearly tells that no executive director must not be allowed to involve in setting his/her own remuneration (ibid). The remuneration committee has the obligation to confer with the chairman and/or chief executive regarding the effectiveness of the proposal framework structured on the executive director remuneration. The committee also has the responsibility to appoint consultants in order to effectively set a potential executive director remuneration policy. If there is an involvement from the part of executive directors of top management in advising or assisting the remuneration committee, due care must be exercised to timely identify and avoid conflicts of interest. It is the duty of the board chairman to ensure that the company effectively communicates to its shareholders regarding various aspects of the remuneration proposal. The section D.2.1 of the Code tells that there should be at least three (it can be two in case of smaller companies) independent non-executive directors in the remuneration committee. In addition, the board chairman may also act as a member of the remuneration committee if he/she is considered suitable for the position. The committee is obliged to explain the role assigned to it and the authority delegated to it by the company board can be viewed at The UK corporate governance code (Financial Reporting Council, 2010). Similarly, the committee must examine whether or not the appointed consultants have any other interest in the company. The remuneration committee must be assigned with the responsibility for setting executive directors’ and chairman’s remuneration, including compensational benefits (if any) and pension rights. However, the company has to give great emphasis on shareholder interests while setting levels of executive director remuneration. Generally, fixed payment for executive directors would not be an effective strategy if the company’s performance is weaker. Under such a situation, companies usually adopt performance based payment approach in order to motivate its executive directors and thereby improve the company’s overall performance. In contrast, companies follow fixed salary approach if their market operations yield higher rates of returns. In short, every company tries to increase its shareholder values while setting remuneration for its executive directors. 2. Traditionally, the UK public limited companies provide their shareholder with a notable influence on shareholder remuneration. However, shareholders decision will not be final on executive directors’ remuneration. In the United Kingdom, public limited company directors have the legal obligation to fully disclose their remuneration details in a ‘Remuneration Report’; the directors may be fined if they fail to do so. According to section 439 of the Companies Act 2006 (cited in legislation.gov.uk, 2006), shareholders have the right of a vote on director remuneration at the accounts meeting held in each year. However, this vote on director pay is non-binding and advisory. Even though this provision is not stronger enough to effectively prevent excessive director remuneration payment, this statue can put a moral check on directors and other top officials. In addition, shareholders can discourage annual bonus payments to executive directors if the business is passing through any kind of market adversity. A separate and binding shareholder resolution is necessary to introduce new incentives or to make substantive changes to the existing director pay schemes. Recently, the Secretary of State for Business, Innovation and Skills announced a director pay package with intent to eradicate weaknesses in the existing remuneration framework. This policy for improving the arrangements of director remuneration has been formally introduced by the UK government. This regulation specifically aims to shareholders’ influence over director remuneration. This provision assists shareholders to establish a clear link between performance and pay and thereby to prevent excessive remuneration payment to company’s directors. The proposal provides UK shareholders with an annual binding vote on future director pay policy. It also raises the support level required on votes to a threshold of 50-75% range (Executive pay: Shareholder voting rights consultation, 2012). The new proposal includes the provision for an annual advisory vote in order to evaluate the efficacy of previous year’s remuneration policy implementation. Finally, it also provides shareholders with a “vote on exit payments of more than one year’s base salary” (ibid). According to this proposal, the company’s future remuneration policy must be detailed in the remuneration report. The details should include potential payouts, performance efficacy, and level of payment to each director. Then the proposed policy may or may not be passed in the annual shareholder voting. Proposed changes to the previous year’ director pay policy will come into effect if a resolution is passed by the shareholders. According to Executive pay (Friendly Corporate PSL, 2012), otherwise, the company will be forced to continue the previous year’s policy or submit the revised proposal in another shareholders’ meeting within a time period of 90 days. However, shareholders will not have the power to cut down basic salary, awards, or pension benefits which were already granted in previous years. Experts opine that the proposed provision would allow shareholders to exercise control over even remuneration policy. Hence, on the strength of the new corporate governance proposal, shareholders can effectively prevent any unfair payment to directors by exercising their (shareholders’) right of annual binding vote on pay. The most fascinating feature of this policy is that it would assist shareholders to serve their own interests in the company. In other words, it can be stated that this proposal would enable shareholders to set the level of remuneration that may be necessary to meet directors’ interests. Likewise, the proposal recommends providing shareholders with an annual advisory vote in order to assess whether or not they are satisfied with the previous year’s pay policy implementation. According to Executive pay (Department for Business Innovation & Skills, 2012), if less than 75% of the shareholders support the previous year’s policy, the company needs to issue a statement within 30 days, explaining concerns raised by shareholders and ways to address them. Such a provision would be beneficial for shareholders to influence the company in structuring the new remuneration policy regulations. Shareholder can directly challenge the excessive director remuneration pay in some other ways too. For this purpose, shareholders having at least 5% voting capital may legally demand the company directors to call shareholders’ general meeting and consider a resolution for overruling the remuneration decision. Finally, the section 168 of the Companies Act 2006 also gives shareholders some extensive rights for removing directors. According to this section, shareholders can remove the company’s unethical director by passing an ordinary resolution in a meeting. 3. Pinto (2004-2005) hold the view that a decline in amount paid to CEO would reflect poor corporate image of the organization. Under such a situation, banks and other financial institutions are less likely to grant loans and other credit facilities for the company and customers may turn to the firm’s competitors (ibid). Simply, a weaker corporate image would negatively affect the market operations and thereby profitability of the company. As Bouwman (2009) points out, restrictions on CEO remuneration would directly add value to CEO’s bargaining position. When CEO’s bargaining power increases, the company members including stockholders and investors may be forced to compromise with various operational requirements. Therefore, institutional investors strongly argue that excessive CEO remuneration would add to the public status of the company. It is precise that majority of the institutional investors invest their money in PLCs for a fixed period and hence they do not have long term interests in those companies or they do not like to take any level of risk. As a result, they focus on the maximum financial gains within the limited period of investment. Moreover, such investors try to maintain a good relationship with persons at the helm of affairs as they (investors) believe that any conflict of interest may adversely affect their financial interests in the company. Generally, institutional investors may have financial interests in many companies and hence they cannot effectively concentrate on every organisation. As a result, they assume that remuneration committee, shareholders, and other regulatory bodies would be concerned about CEO remuneration and therefore such bodies may pay due care in fixing CEO pay at proper levels. Finally, institutional investors are of the view that excessive remuneration would largely motivate CEO and which in turn may add to financial prosperity of the company. Obviously, an increase in the company’s revenues would directly contribute to its profitability as well as reputation. From the given article (Neate, 2012), it is obvious that institutional investors including the government were reluctant to challenge the Hester’s controversial bonus. The article says that intense public and political pressure forced Stephen Hester to give up the bonus amounting to nearly ?1m, but not governmental pressure (ibid). Here, it is clear that the government was so reluctant to exercise its legal powers as a majority shareholder (82% state owned) to challenge Hester’s controversial bonus. As we discussed earlier, the government thinks that a cut in CEO bonus may demotivate the CEO and ultimately this policy may adversely affect the bank’s profitability. In addition, public limited companies including Royal Bank of Scotland greatly contribute to UK’s economic growth. Hence, the government holds the view that CEO pay cuts and thereby PLCs’ poor performance would negatively add to the country’s overall economic growth. As a result, the government always try to be in good relation with the company CEO. It seems that the government only focuses on the short term benefits rather than plan for the future. Moreover, the government is not completely aware of the far reaching consequences of excessive CEO remuneration. Moreover, the government thought that the ?1m bonus payment would directly reflect the financial stability of the Bank and such a company image may attract more and more new customers. Finally, the government also tries to stimulate other PLCs by convincing them that it (government) would not interfere in company operations. References Bender, R & Porter, B., 2003. Setting Executive Directors’ Remuneration in Listed Companies, JAMAR, 1(2), pp. 27-47. Bouman, CHS., 2009. The geography of executive compensation, pp. 1-49, [Online] Available at: [Accessed 28 March 2012]. Collier, PMM & Agyei-Ampomah, S., 2009. CIMA Official Learning System Performance Strategy, Netherlands: Elsevier Science. Department for Business Innovation & Skills., 2012. Executive pay: Shareholder voting rights consultation, pp. 1-40, [Online] Available at: [Accessed 28 March 2012]. Financial Reporting Council., 2010. The UK corporate governance code, pp. 1-35, [Online] Available at: [Accessed 28 March 2012]. Friendly Corporate PSL., 2012. Executive pay: Government proposes that annual binding vote will need “supermajority” to pass, [Online] Available at: [Accessed 28 March 2012]. Genius Methods., 2010. Main principles of the UK corporate governance code, pp. 1-3, [Online]: Available at: [Accessed 28 March 2012]. Legislation. gov. uk., 2006. Companies act 2006, [Online] Available at: [Accessed 28 March 2012]. Neate, R., 30 January 2012. RBS boss Stephen Hester waives bonus: Reaction, The Guardian, [Online] Available at: [Accessed 28 March 2012]. Pinto, M., 2004-2005. The role of institutional investors in the corporate governance, EMLE, pp. 1-71, [Online] Available at: [Accessed 28 March 2012]. Read More