The complexity of executive remuneration

Incentive programmes with provision for clawback mean that when executives miss targets, their bonuses could be withdrawn, writes John McGill.

A topic that draws mixed opinions, determining executive remuneration, can be a complex process. Typically, the responsibility of a board of directors, it is considered a particularly important duty of their corporate governance. 

Awarding executive pay is a zealously guarded function of the board and with good reason. The board of directors represents the views and opinions of the shareholders and is responsible in part for safeguarding their investment. 

Quite how much leverage is afforded to shareholders varies across individual companies, but in any case, it’s very much in the board’s interest to represent their shareholders’ opinions as accurately as possible. 

That means they must create a remuneration strategy that is results-focused, fair and that they can justify and discuss when called upon. 

Beyond shareholders, directors should be looking to organisations such as NZX and the Institute of Directors for advice and best practice. While there is a code for listed companies, many non-listed businesses also look to align themselves with best practice. The Institute of Directors has produced comprehensive guidelines around remuneration that are useful for boards to consider. 

Boards must be able to justify their decisions around executive remuneration and are encouraged to use best practice guidance.

 

Incentives and performance 

Awarding the right level of remuneration requires the ability to balance external factors and apply them to the individual circumstances of the company. Committees should be looking at what similar organisations are offering, the industry market rate and how competitors deal with short and long-term incentives.

There is plenty of data available that provides a good indication of what’s acceptable in the current market. In New Zealand, the makeup of the pay package is not like the US, where the base pay could be worth as little as 20 percent of the overall figure. In New Zealand, base salary makes up 60-80 percent, with short-term incentives on top, and possibly some long-term rewards as well.

There is continuous debate about the usefulness of short-term incentives versus measuring long-term performance. Short-term incentives tend to be more popular as success is more immediately measurable and goals can be adjusted as a result.

It can be easier to visualise what needs to be achieved in the short term, with a significant amount to measure as to what an executive achieves in day-to-day management of operations, reporting and budget efficiencies. Long-term incentive options require the board to wait up to three to four years before it can ascertain success.

Arguably, long-term projects have the potential to make a bigger difference to the company and to increase the value of shares over time. A project that takes three to four years could involve significant changes to the products or services offered, which couldn’t be achieved within the time frame of a short-term incentive.

Another consideration for boards is the Royal Commission’s recent support for the idea of financial clawbacks as an effective way of managing executive under-performance. Incentive programmes with provision for clawback mean that when executives miss targets, their bonuses could be withdrawn. What’s more, this could happen in hindsight, even months after incentives have been awarded. 

Transparency around pay is becoming more common and important. The Corporate Code of Governance encourages organisations to provide a level of transparency around how they determine executive pay. Further, the Companies Act requires businesses to provide details around remuneration for any employee earning over $100,000, within $10,000 bands. However, cynics feel that greater transparency increases executives’ pay without requiring better performance, as companies must compete with what other organisations are offering. 

Navigating executive remuneration, shareholder investment and public interest can be complex. It pays to use advice, plans and market reports to help you reach a decision.  

John McGill is the chief executive officer at Strategic Pay.

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