Why executive remuneration should be directed by the board

Executive remuneration is at the centre of an ongoing global debate. Some argue against what is perceived as an unfair distribution of wealth, while others claim that executive remuneration is determined by the market and appropriate to the KPIs of an executive role. By John McGill.

Once upon a time, a board of directors may well have considered their involvement with executive remuneration to be an interference in how the company gets run. These days, the same approach would be considered bad corporate governance.

Executive remuneration is about far more than the dollar amount. It’s about retaining key talent and incentivising high-performance. This, in a nutshell, is why the board of directors should oversee, or at the very least have an involvement in, remuneration packages for executive officers.

 

The ongoing debate

Executive remuneration is at the centre of an ongoing global debate. On one hand, people are arguing against what is perceived as an unfair distribution of wealth, while on the other, many claim that executive remuneration is determined by the market and appropriate to the KPIs of an executive role. 

Of course, the issue is far more complex than that, more so than we have space to elaborate. But one thing is clear – transparency is all important – to the shareholders, the company and to the public at large.

The last point is important and not just for listed companies. Cooperatives (Fonterra and Ravensdown for example), public sector organisations and anyone producing an annual report are increasingly being seen as required to explain executive pay, its structure, the quantum’s of pay, and CEO accountabilities. However, formally in New Zealand at present, the most stringent rules are for listed companies.

The NZX Corporate Governance Code recommends the following:

• Remuneration should be based on the scale and complexity of the role. It should reflect the performance requirements and expectations attached to an executive role.

• Performance-based remuneration should be explicitly linked to clearly outlined targets that align with the organisation’s business objectives. It should be appropriate to the company’s risk profile.


Equity-based remuneration should be designed in such a way to support long-term objectives and not promote unnecessary risk taking.

There is no one-size-fits-all approach to executive remuneration strategies and establishing a framework for remuneration is fairly complex and should be undertaken on a case-by-case basis.

 

What role should the board take? 

An executive pay package should be effective for the company, attractive to the executive, and justifiable to shareholders – after all, the entire executive remuneration arrangement must be disclosed in the annual report. The board should, at the least, work to ensure that executive remuneration ticks the aforementioned boxes. While directly involved in all aspects of CEO pay, boards are also increasingly taking a greater interest in the second tier of the organisation in terms of remuneration policy as well as the actual structure of the remuneration. 

Robust decision-making in these latter arrangements are also important as it will be the board that will increasingly be put under the spotlight when the issues are raised either at AGMs or other forums to explain policies, pay-outs, or problems.

A board may not have the resources or knowledge to build up remuneration packages from scratch, and may opt to seek advice from a third party consultant. This is fairly common, with a recent PwC report noting that after 900 public companies were surveyed in 2017, 90 percent had worked with a compensation consultant to create effective executive remuneration packages.    

 

John McGill is the CEO at Strategic Pay.

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