Jeremy Thorn, Non-Executive Director of a wide range of organisations and frequent writer and speaker on management topics, looks at the important and challenging work of any organisation’s Remuneration Committee and specifically looks at how Directors are to be rewarded?
Most Boards find that agreeing the remuneration packages of their Directors is a fraught and often time-consuming process. This is particularly so in growing organisations, where there may be little tradition of establishing due policy, process and principle as yet, and especially where Directorships may be tied up with further complications of share-ownership.
In the early days of any company, the Executive Directors (especially if they are co-shareholders, as is often the case) tend to have a tacit agreement between themselves of a ‘going rate’ for their pay, bounded first by what they feel the business can afford. But as any business grows, and especially as new Directors are appointed, such cosy agreements between all the Directors cannot always be assured.
It is at this stage that a wise Board will elect a Remuneration Committee, most often comprising the Chairman and any Non-Executive Directors, advised ex officio by the Managing Director. This Committee necessarily reports to the Board, as would the Audit Committee – and indeed perhaps an Appointments Committee for new Directors too.
This is often where experienced Non-Executive Directors can be particularly worth their weight in gold, in trying to apply the rarest ‘Judgment of Solomon’ to find the best way forward in agreeing what can be one of the most highly emotionally-charged decisions any Board may need to take: who should be paid what?
There are several essential guidelines that might be helpful in establishing a Remuneration Committee.
The first is that it is vital that the remit and composition of the Remuneration Committee is agreed with the Board at the very outset, and indeed its processes and principles.
A Board may of course be at liberty to over-turn the recommendations of any of its sub-Committees, with good reason, but this should be rather like asking for a new referee half way through a football match. The inclination to do so may be quite frequent for those individual Board members who don’t like the decisions made! But it should take quite extraordinary circumstances to achieve this in practice, especially if the rules are well-established and the agreed processes duly followed.
Apart from a clear remit and constitution, the second guideline is that it is essential that a Remuneration Committee’s members are fully in tune with both the broad operations of the organisation and its Executive Directors’ performance and aspirations, which is why the Managing Director’s ex officio involvement may be so important to help guide the Committee.
Thirdly, it is also important that its members are well briefed on the going market rates outside the organisation for equivalent posts elsewhere. If they don’t know, they need to find out. Most professional Institutions publish detailed salary surveys every year; relevant recruitment consultants may often willingly offer free guidance on current rates to gain your interest in their services; and there are many other employment-research agencies who would be glad to offer their professional advice for a fee.
Finally, and perhaps as important as any other consideration, it is critical that the membership of this Committee is completely impartial. The benefit of making this Committee ‘non-executive’ is that none of its members should have their own axes to grind. Both real and perceived impartiality is vital.
There are many core principles that might be helpful in determine any Board’s remuneration policy for its Executive Directors. One of their first tasks is to agree the hierarchy of these. Here are six you may wish to consider.
1. Short-term Affordability by the business overall
The affordability of any recommendations by an organisation is often a matter of fine judgement. It therefore usually lies within the Chairman’s final remit to decide, in discussion with any major external shareholders. It can be an iterative process, but this test of short-term affordability must come first. The Board of any company may not accept any overall remuneration package that is not in tune with the organisation’s ability to pay without breaching its fiduciary duties.
This may well mean that if some individuals in a Board need to be treated exceptionally in any given year, others may have to be less favourably treated. But deciding this must be the Remuneration Committee’s task first, for who else might?
2. External Market Rates and professional parity
Remuneration packages are most usually related to company size, sector, profitability and location first; and detailed role, scope, experience/longevity and qualifications; followed of course by individual performance, capability, flexibility, future potential and commitment — most especially as perceived by senior stakeholders.
Any lack of perceived professional parity can result in a rapid exodus of capable staff at any level in any business, given an open market for similar skills elsewhere. Other factors may well influence this concern more individually however, such as financial commitment, private agendas and ambition, domestic ties, personal loyalty and shared values. But after ‘affordability’ by the company as an entirely practical concern for the longer-term health of the business, this issue can be the next most important.
3. History, and past personal commitments
Needless to say, it is vital for a Remuneration Committee to be aware of the history of its Board’s remuneration and past promises. Very often, the historic salary progression of different Board members can produce strange anomalies going forward and it is rare for these to be capable of being addressed all in one go. For those who appear to have been over-paid relative to their peers, it is rarely possible to reduce a salary, but it is not at all unusual to ring-fence this for a period of some years, to let others catch up. For those who have been significantly under-paid in the past however, it is often necessary and more realistic to deal with this more quickly. Nevertheless, many Boards may be wary of eliminating a substantial shortfall in a Director’s pay all in one go, especially if it may set up unrealistic expectations by the person concerned for equally glamorous salary increases in the future.
Meanwhile, many organisations may find themselves in difficulties from time to time with private deals and promises that some senior executives may have had in the past, that are no longer in line with their peers. For any ethical company with strong corporate values and integrity, these cannot be unilaterally discarded without at least considerable care. But it may be a very wise company that will seek to negotiate any anomalies out for the future, as soon as possible, as these can become highly disruptive.
4. Relativity and perceived equity
This is the essential ‘felt-fair’ factor. It is not to be ignored! Any organisation’s employees may be willing to accept a perceived or actual salary sacrifice for example, if short-term circumstances demand, or if the senior team agrees to live with a below-market rate for any other reason (such as building longer-term security). But their willingness to do this may never be presumed and success is entirely dependent on such a policy applying to all, equally.
Related to this, is the wider issue of perceived equity, which does not mean ‘equality’! Some Boards find it more harmonious to pay all executive Directors the same, especially in their early days. However, if you look at the salaries paid to Directors of publicly-quoted companies, you will note this is very rarely the case. Different Directors may certainly be ‘worth’ different amounts, and they may surely have different market values in the external market. New members of a Board in particular can find it quite hard to appreciate this, but it is a fact of life and may need some sensitive explanation.
5. Longer-term issues to support the business going forward
A company’s first duty, and therefore the Board’s, must be to support the Company rather than any individual. This can present a genuine dilemma for faster growing companies, especially with a young Board with equally fast-growing families! Nevertheless, the principle of ‘jam tomorrow’ is almost always the most prudent. Too many good organisations have been destroyed in the past by its Directors paying themselves more than their business can realistically support.
6. Bonuses, Share Options and Dividends
Bonuses are a time-honoured approach to rewarding exceptional performance exceptionally, at many levels. They deserve an article in their own right. Generally, these should be an executive management issue agreed by the Board as a whole against formal performance targets. For Directors, however these may fall within the remit of the Remuneration Committee, and the trick here is not to let the precedent set by the bonuses for other staff tie their hands in deciding those for Directors!
Share options can be very powerful and tax-effective ways of rewarding (and retaining!) key employees over the longer-term — the ‘jam tomorrow’ as identified in 5 above. They will need specialist advice however in their construction, which is always well worth paying for, suitably selected.
For new and smaller companies where the Directors may also perhaps all be shareholders, reward through longer-term equity growth – and more tactically, dividends – can be highly motivational. They can be even more valuable than annual salary or bonuses. The problem comes however with new shareholding Directors who join later, who may be just as critical to the business if not more so than the original shareholders, where their ability to be rewarded fairly by dividends becomes increasingly less possible with their smaller shareholdings. It is vital that new, key contributors do not feel that their overall remuneration may be prejudiced by having smaller shareholdings and so, almost always, it is therefore critical that dividends for shareholders are treated separately from the organisation’s core remuneration policies.
– The problems of any perceived anomalies in Directors’ remuneration can only grow worse, the longer they are left unattended.
– Such problems may be most acute with newer organisations, where both relative and actual remuneration between the Directors have seemed rather unimportant when they first started. But even in mature organisations, where the process of determining Director’s pay may be well-established, some essential agreed principles are still essential, if only to allow for the operational flexibility that may be necessary to recruit and retain new candidates without disenchanting existing ones.
– It is essential that firm, objective remuneration policies and principles for Executive Directors (and others) are agreed by the Board as soon as possible.
– It is also invaluable that the detailed application of these policies and principles should be advised by experienced Non-Executive Directors in a formal Remuneration Committee, whose members have nothing to gain from their deliberations personally, suitably briefed by the Chief Executive ex officio to ensure they reflect both the actual performance and impact on the ground.
– The work of any Remuneration Committee can be thankless! There may always be individual beneficiaries who may feel badly done by. But as long as the agreed principles and processes have been adhered to impartially, there may be no better way.
Jeremy Thorn has led both small and large businesses in the UK, Europe and North America. He has also written several award-winning books including ‘The First-Time Sales Manager’, ‘How to Negotiate Better Deals’ and ‘Developing Your Career in Management’, and a number of popular Tips Booklets for practising senior managers, born out of his hands-on practical experience.
Jeremy consults extensively on business and management development, culture change, marketing and business strategy internationally. He is also a Non-Executive Director of several fast-growing businesses in the UK, a business coach and a frequent speaker to the Academy for Chief Executives and many other organisations. His passion is in helping others to develop great organisations – and great people within them