In terms of governance, what is a remuneration committee, what work does it carry out, and who sits on it? This Lexicon guide explains more.
What is a remuneration committee?
There can be much involved in deciding on how senior executives are rewarded (remunerated). Still, it is clear that reward is essential for motivating such executives to achieve a positive outcome for shareholders.
However, with much controversy concerning directors’ compensation in recent years, shareholders and investors are now taking a greater interest in this area.
Deciding how remuneration should work in practice is the goal of the remuneration committee. Compensation should always be tied to performance.
This article will examine who can be members of the remuneration committee and their duties and responsibilities.
“There should be in place an appropriate reward policy to attract executives who will achieve results in the interest of the shareholder.”
The work of the remuneration committee
The remuneration committee should have an appropriate reward policy to attract executives and non-executives who will achieve the interests of shareholders. The work of the remuneration committee involves setting the policy on the remuneration of senior management personnel.
The committee will also be responsible for:
- Reviewing the terms and conditions of employment along with the compensation of senior directors and managers
- Deciding on termination payments for executive directors and the chairperson
- Reassuring shareholders that remuneration is decided fairly and transparently with no conflicts of interest
Who should sit on the remuneration committee?
The committee should be mostly made up of independent non-executive directors, which will avoid conflict of interest around the issue of compensation for senior management.
The remuneration committee should have a high level of understanding of both internal and external factors that may affect their decisions, including the factors above and the business culture.
The committee should understand the company’s existing approach to remuneration and the current policies in terms of notice and severance agreements. They should realise any exceptions or special arrangements and how management has been paid to date.
How should remuneration be decided?
The components to consider for executives remuneration would be fixed basic salary, which could be related to the market practices of similar companies. They will also consider performance-related bonuses and what share options will be provided to executive directors.
Factors that may affect remuneration include company size, performance record, industry sector, geographic location, cash flow, and KPIs.
Since pay for directors may be monitored by several others outside of the business, the role of the remuneration committee in ensuring fairness and transparency is vital. For this reason, it is helpful for the committee to have a thorough understanding of all interest groups and stakeholders in the market.
Data on the market and the compensation for others in the same industry sector will be of use to the committee in deciding on and justifying appropriate compensation levels.
So, we have seen that with increasing attention being paid to the remuneration of directors by shareholders and investors, there is increasing pressure on the remuneration committee to strike a balance between compensation that is fair and, at the same time, competitive. There is some variance across industries regarding such payment, so it is helpful to have a specific committee to advise the board on this. While almost any board member can serve on the remuneration committee, providing there are no conflicts of interest, it would be best if at least one has experience in developing remuneration packages.
Below is a sample checklist of responsibilities of the remuneration committee.
- Review the conditions of the chairman of the board and the executive directors’ remuneration and terms of employment.
- Maintain a record of the remuneration structure and level of senior managers.
- Set detailed compensation and termination payments for executive directors and the chairman
- Make sure that executive directors are fairly compensated for their contributions to the company’s performance.
- Shareholders need to be assured that remuneration of the executive directors is set by individuals who have no personal stake in how decisions are made.
Ideally, executives and directors must be rewarded in a way that attracts, retains and motivates them while striving to satisfy shareholders’ interests at the same time. Following is a list of typical components of an executive director’s compensation package.
- Fixed compensation. Based on the terms of the executive director’s employment contract, this will usually consist of their basic salary, superannuation, and fringe benefits. Performance is not linked to this compensation. Fixed remuneration is generally based on market practices for peers with similar business models. However, if the executive director comes from offshore, the level of pay for their home country may need to be considered by the search committee.
- Cash bonuses may be paid to executive directors who perform excellently and may be accompanied by deferred shares.
- A share option is a right to purchase shares during a specified time in the future at a specific price. An increase in the share price gives directors an incentive to increase the company’s value. Since the directors become owners, share options are believed to align executive director goals with shareholders, eliminating agency problems.
- Many remuneration guidelines also specify that options should not be exercisable in less than three years and that the shares should not be offered at a discount.
- If it is a defined benefit plan, superannuation is generally included in the fixed compensation package.
If the committee considers a basic salary increase, it should also consider any bonus payments, which in many organisations also provide superannuation benefits.