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The Role of the Board Remuneration Commitee: How Remcos function in determining top executive pay Extract from PARC Research Report March 2006
Copyright Š 2010 PARC Ltd. All rights reserved. Published by PARC Ltd, One Heddon Street, Mayfair, London, W1B 4BD, UK. Telephone +44 (0)20 7432 4565 Apart from any fair dealing for the purposes of research, private study, criticism or review, as permitted under the Copyright, Designs and Patents Act 1988, this publication may only be reproduced, stored or transmitted, in any form or by any means, with the prior permission in writing of the publishers. Enquiries concerning reproduction outside these terms should be sent to the publishers at the above address.
Contents 1 Executive Summary
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Introduction
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2 Players and Stakeholders in Executive Pay
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2.1 Internal to Companies
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2.2 External Players
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3 Conclusions and Recommendations 3.1 The Feasibility of the Remuneration Committee Charter
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3.2 The Key Competences and Practices of an Effective Remuneration Committee 11 3.3 The Role of the HR Function
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Executive Summary concern itself with broader issues than the pay of a limited number of executive directors; it is a widely held view that the committee should be probing more deeply into the performance of the organisation and of the executives.
This report followed the 2005 PARC study on The Role of the Board in Creating a High-Performance Organisation. It focussed on exploring the role, processes and practices of the Remuneration Committee in a number of major companies. Based on confidential interviews with Remco members, HR executives, consultants and others, a number of key issues emerged from the research:
Together, these issues raise the question of what constitutes an ‘effective’ Remuneration Committee, as assessed against the varied background of expectations and needs of the various stakeholders. The report then moves on to offer conclusions and recommendations in three key areas:
• The charter of a Remco, as defined in the Combined Code and elsewhere, though reasonable in concept, can be troublesome in implementation. As a result, some Remco practices seem to adhere more to the basic requirements of the Code than perhaps the spirit. Nonetheless committee members are generally conscientious and committed to improving their overall effectiveness.
• Is the charter of the Remuneration Committee feasible? Specifically, is ‘independence’ of committee members either necessary or possible? What do we mean by effectiveness of the committee? • What does a successful Remco look like? Here, the critical role of the chair is highlighted and explored, as is the composition of the committee. The Remco sits in the centre of a web of overlapping relationships that need to be carefully managed.
• One underlying problem seems to be the question of ‘independence’ of the key players in the Remco process; not only of the members themselves but also of others involved, such as external consultants and the internal HR function. • A further underlying problem seems to exist in the expressed requirement to ‘pay for performance’. The report suggests that many Remcos pay insufficient attention to this key aspect, both in terms of the time spent upon it and also in terms of the depth of the analysis.
• What can the human resources profession do to contribute to the effectiveness of the Remuneration Committee? There seems to be a variety of views, roles adopted and scale of HR influence. The report considers that a good Remco will establish clear independence from ‘technical’ advisers, namely the HR function and external consultants, who are generally seen as having a growing influence. Nevertheless, the HR function has a crucial role to play in promoting the
• Time pressures are seen as a huge restriction for the effective working of the committee, especially in view of the growing belief that the Remco needs to
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The Role of the Board Remuneration Committee: How Remcos function in determining top executive pay
effectiveness of the committee’s operations, and specific suggestions are made, particularly with regard to the nature of the Remco’s agenda and process.
particular, the Remuneration Committee needs to occupy itself to a much greater extent with the issue of performance management, corporately and individually. Finally, the report concludes that meeting this challenge will largely depend upon the committee itself carrying out regular reviews of the effectiveness of its own decisions and working processes.
Remcos in general still have some way to go in order to meet fully not just the letter, but the spirit and intent of the Code and there is a need for vigorous and active work by the Remco with a strong chair. In
Introduction moving on to a consideration of the key competences and practices which characterise an effective Remco. Finally, we set out a number of recommendations relating to the role of the HR function in increasing the effectiveness of the Remco and related processes.
To frame the research findings and conclusions, this report first provides an overview of the key players and stakeholders in executive pay process, identifying their respective roles and the issues associated with these. Within this context we then go on to evaluate the feasibility of the Remco charter before
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2 The Players and Stakeholders in Executive Pay Remcos do not operate in a vacuum. They are subjected to a wide variety of influences coming from a large number of sources as depicted in the following diagram and as outlined below:
Main Players and Influences REPUTATION
The public
INTERNAL
EXTERNAL Media
Investors
Corporate chair Remco chair
Analysts
Main Board
The Remuneration Committee and non-execs CEO
Regulatory bodies
Executives
External consultants
HR Director
Remuneration & Benefits Director
ADVISORY INFLUENCES
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The Role of the Board Remuneration Committee: How Remcos function in determining top executive pay
• The Executive: We detected different stances and practices among Remcos. For example, in one case, the Remco endeavoured to detach itself entirely from the CEO and his staff, using external advisers completely independently and initiating proposals for reviews of pay. In this case, the role of the HR function was significantly diminished. In other cases, the Remco received proposals from the executive through the CEO, used the HR function to interpret and supplement external advice and involved the CEO in discussions about the performance of subordinates, excluding him or her only from discussions about his or her own remuneration. The independence of the Remco from the influence of the executive is an important consideration, but difficult to manage.
2.1 Internal to Companies • Remco Chairs: Some respondents described the Remco as having a less important and interesting role than, say, the Audit Committee. It is thus even more important that Remco chairs should punch their weight in the wider board. The roles of the chair include: to interpret the governance requirements and determine the scope and charter of the committee, and to set priorities and standards in such matters as being informed on performance and strategy, and therefore the effectiveness of the executive. The chair will set the annual agenda for the Remco and determine the relationships with the corporate chair and executive. They will also set the climate for meetings and communication between Remco members outside meetings. Remco chairs will determine the nature of relationships with external advisers and the HR function.
• The HR Function: HR and internal remuneration and benefits functions’ involvement with top executive remuneration varies widely. In some cases, it involves commissioning and interpreting market analyses, making policy proposals and acting as secretariat to the Remco. At the other extreme, there are cases where HR has much less contact with the Remco, with external advisers reporting directly. In between these extremes, there is a wide range of practices. The role of HR seems to depend on the attitudes of the Remco chair, the position and expertise of the HR director and the degree of trust existing between the executive and HR on the one hand, and the Remco on the other. In some cases, the HR function was regarded as an ‘honest broker’ between executive and non-executive functions. We found some cases where the HR function (director and/or remuneration & benefits director) seemed to wield very significant influence over the Remco. The nature of this influence can be problematic.
• Remco Members: In the main, membership of the Remco will be shaped by the chair, but also by the ‘charter’ of the committee. For example, there is a wide variety of practice in relation to the constituency that the Remco seeks to address – some Remcos concern themselves only with executive directors and only remuneration, while others seek to influence compensation policy and practice for a wider group of executives and take an active interest in appointments, recruitment and development. • Board Chair and CEO: The quality of the relationship between board chair, the CEO and the Remco is obviously of crucial importance, the more so in recent times because of the increasing weight of investor and media scrutiny. This is often the most sensitive issue for the Remco chair to manage.
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interviewees described a changing role for consultants. These changes might be described in two key dimensions. Firstly, the emergence of ‘stars’ among consultants – individuals whose reputation, contacts and influence makes them sought after. Secondly, increasing activism on the part of advisers. Many respondents described consultants as developing ‘ideas’ for new developments in compensation practice and in some cases actively promoting their ideas to companies, regulators and even investors. It also appears that some of the increasing complexity of pay and benefits practice may originate with consultants. Consultants are aided by governance requirements to use independent external advice. In many cases, it now seems that many companies have two separate relationships with consultants – one to the executive, often through HR – and one directly and independently to the Remco. In some cases different consultants may provide the advice, in others the same consulting company.
2.2 External Players One of the most important developments driving top executive compensation has been the development of an active market for executive talent (real or assumed). Large companies that are driven by a desire for exceptional performance have to play in the market and pay the going rates or they will lose talent and not be able to attract the ‘best of the best’. Many of the external players described are actively involved in driving or moderating the market. We have therefore described their roles in relation to its functioning: • Executive Search Consultants: There is a relatively small band of consultants who specialise in top appointments, both executive and non-executive. Many search consultants are strongly of the view that there is an international market for exceptional people, thus contributing to its creation and maintenance and a resultant escalation of executive pay levels. Search consultants are sometimes used by companies to take soundings with investors about individuals for appointments – such soundings may also include an outline of the intended package. It would appear that investors are much less sensitive about the size of the package if it can be demonstrated that the company and search consultants are looking for a really ‘big hitter’. Thus regulatory pressures are much diminished when external appointments are made – and an expensive external appointment inevitably has internal knock-on effects.
• Investors: The impact of investment institutions can be inconsistent and variable. The driver of investor behaviour is their view of individual managers and even management teams. If a company and its leadership are well-rated at the time, there is considerable scope to leverage packages upwards. However, in times of difficulty, it was reported that investors were more disposed towards high-profile, highly rewarded external appointments. Internal appointments were treated more stringently. • Analysts and Media: These have been grouped together because there are close links between sell-side analysts, investors and financial journalists. The media feed off stories, reactions and rumours coming from the financial markets. Equally, the markets are well-practised in providing the
• Remuneration Consultants: At one time consultants were seen as useful providers of comparative data and technical design skill – acting as a sort of ‘lubricant’ for the executive pay market. Now, many of our
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The Role of the Board Remuneration Committee: How Remcos function in determining top executive pay
press with their views on a myriad of subjects, including performance, reputations and remuneration. The impact of this inter-linked ‘system’ of communications on boards, Remcos and individual executives is extremely strong – the triumvirate of investor, analysts and press is felt by top managers to be a key determinant of their reputations, tenure and wealth.
aspect of this phenomenon is the circulation of stories about such highprofile figures, and the business and investor communities seem to hang on their every word. This is relevant to Remuneration Committees because it leads to the theory that there are executives with almost infinite worth, especially in times of difficulty, whose pay cannot be judged by ‘conventional’ criteria. It can also reveal situations where the company displays a tendency to value individuals rather than the company or value a ‘superstar’ more than the power of executive teamwork.
• Industry and Investor representative bodies: The power of these bodies has grown considerably on the back of the various governance codes, but also reflecting increasing investor activism. Influence is typically exercised through the threat of hostile reaction to specific proposals by individual companies, with the accompanying publicity – but also the possibility of mobilising investors to vote on proposals. ABI and NAPF have governance functions that are extremely active in giving advice and reactions behind the scenes to companies and consultants.
• Government: The role of governments – of all political colours – in influencing the development of executive pay practice has historically been indirect, and mainly limited to commissioning committees to investigate and make recommendations for voluntary action, plus distant exhortations and threats when the public outcry has become uncomfortable. In essence, what this seems to suggest is that, prior to recent developments, the power of the City has exceeded the power (or at least the will) of the Government in addressing executive pay.
• High-profile Individuals: A most interesting phenomenon has been the growth of ‘superstar’ managers. A fascinating
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3 Conclusions and Recommendations This section briefly summarises the main conclusions drawn from the research and also offers some recommendations in respect of what may be considered to represent ‘good practice’. The term ‘best practice’ is deliberately avoided, as management practice should be related to the context and the specific needs of the organisation. Remco matters in particular seem to us to be highly contextual in nature. Our comments will be set out within the framework of our three research questions:
‘optics’ of that process seem to be heavily emphasised. Our conclusions relate to the following five specific aspects of this outcome: independence, inputs, pressures, time factors and definition of effectiveness. Independence There are particular issues surrounding the independence of some of the key players in the Remco process: • Non-executive directors – Company law does not distinguish between executive and non-executive directors in terms of legal status and obligations. Ultimately, both share a similar accountability in the issue of corporate governance. Multiple board and committee memberships can result in ‘overlapping’, or circular interests. Furthermore, one Remuneration Committee chairman in our research expressed the view that the Audit Committee was the more important and demanding committee and the Remco was 'much lower priority '. The research also suggested that it was not always easy to find uncommitted non-executive directors to sit on the Remco and we heard the comment that it was 'more by luck than judgment' that good Remuneration Committee members were selected. This obviously needs attention.
1. Is the commonly held remit of the Remuneration Committee as set out in the Combined Code and elsewhere actually doable? Is it a fair and reasonable expectation? 2. What does a more effective Remco look like in terms of its competences and practices? 3. What support can be provided by the HR function to improve the chances for more effective action on the part of the Remco?
3.1 The Feasibility of the Remuneration Committee Charter
• External advisers – There has been much debate in recent years concerning the nature and extent of the independence and objectivity of external advisers: how is it possible for them to be truly independent when they are in a provider/client relationship? To what extent might they be compromised by working for a number of Remcos, including different Remcos that
The evolution of the Remco concept has been driven largely by political and institutional reaction to debates over ‘fat cats’ or ‘rewards for failure’.The outcome of this has been an attempt to codify a process with general established standards and expectations, where the
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The Role of the Board Remuneration Committee: How Remcos function in determining top executive pay
might have members in common? To what extent might they also be dependent upon the company for other consulting work? Consultants can be truly independent only to the extent that they are able and willing to walk away from a client.
continues to be market data, which has served only to ratchet up pay. The question this raises is: has too much emphasis been placed on the levels of basic pay and incentive, and a comparison of competitiveness against these levels? Remuneration Committees might be better engaged spending more time looking at performance compared with other companies and against their own plans and strategies. Thus issues around inputs from consultants include:
• The HR function – Again, this is a longrunning debate over the nature of the function: To what extent is it fair and reasonable to expect the HR (or remuneration & benefits) director to be truly independent when (s)he is an integral part of the executive team reporting to the CEO? Why should the HR function be expected to be a breed apart in this regard if they aspire to be the ‘business partner’ of the executive? We conclude that ‘independence’ in this context is a somewhat tenuous notion and suggest that it may be more realistic to view independence here rather as a state of mind, or to focus instead on the notion of “impartiality “ rather than “independence”. Some interviewees in the research questioned whether the desire for ‘independence’ could create too much distance, stating that the Remco chair should have personal contact with the executives to ascertain their needs and expectations. Others insisted that they should not have such a relationship with the executives, leaving that aspect to the CEO and to HR. This is challengeable. After all, the executives are key stakeholders of the Remuneration Committee's deliberations, and it is generally good business practice to understand the target constituency. Ultimately, of course, these matters will boil down to the competence and character of the key players themselves.
• A perceived growing influence of consultants and the relatively small number of providers. • A number of Remuneration Committee chairs expressed the view that providers of data fuelled the increase in pay levels, through the surveys and samples used. • How independent can the consultants really be, given their reliance on the paymaster? • How linked are the external consultants and the internal HR function, and can the two together really give sufficiently independent views to the Remco chair? • One of the companies interviewed mentioned that they had an independent resource available to them. This person was employed by the company on a consultative basis; had not made the original recommendations, but instead organized and supported the Remco in its operations. This struck us as potentially good practice. • Most of the companies said that external advisers attended meetings only as required. There were a small minority who said they always attended, and in fact in most cases consultants were present for at
Inputs The core information input to the Remuneration Committee's decisions
Précis of PARC Research Report
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least some part of the meetings. This raises the question whether this places too great an emphasis on the role of the consultant and allows them too much influence.
Pressures acting on the Remco Again, we have earlier described the range of pressures acting upon the Remco, both external and internal. There is a range of complex relationships to be accommodated and managed and what one commentator has described as a ‘circularity of influence’ acting upon the Remco, which can be seen as leading to a rather closed world or ‘bubble’ within which the Remco is forced to operate.
improve its diversity. Definition of Effectiveness What does effectiveness mean and by whose criteria? This issue recurred constantly in our research. Effectiveness seems to be in the eye of the beholder, not to mention the stakeholder! Likierman (2006) draws an interesting distinction between effectiveness and success, analogous to that between doing things right and doing the right things. Our research indicated a definite tendency towards the former, with comparatively little attention to success measured in performance terms.
The Time Factor
RECOMMENDATIONS
Another factor which very much affects the practicality of the Remco remit is that of time. In recent years, the Remco has risen
If all of those factors are considered together, it has to be said that the overall charter as presented for the Remco is not a totally realistic proposition, representing an unrealisable expectation of some of the key players and of the Remco itself. In reality, the outcome will depend to a great extent upon the character, competence and commitment of those players and, above all, the role and performance of the Remco Chair. Furthermore, there may be scope for a different kind of adviser, who can be called upon as necessary or appropriate to give a view on what is being proposed or recommended. A ‘second line’ adviser, more distant, could give essentially a second and more distant opinion on the advice of the front-line players who are at the heart of the issue.
from being perhaps the Cinderella of the Board committees to being a committee squarely in the front line of highly visible and potentially controversial decision-making. The issues are seemingly more complex, with increased requirement for ‘technical’ knowledge and background. Thus, it can become increasingly time-consuming, time which competent, much-in-demand nonexecutives do not have in abundance, particularly if the Remco is keen to address broader issues beyond pay or if board members are serving on several different boards. This is an area that continues to require attention, with an apparent need to increase the board member population and
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3.2 The Key Competences and Practices of an Effective Remuneration Committee
into a reward plan and determine results against that plan. One company we spoke to also had a clear position on this: the board sets the budgets and the Remco takes the budgets as ‘targets’ for bonuses, etc. and then has responsibility for establishing the performance range (minimum and maximum) around which reward is structured.
To a large extent a Remco can only be as effective as the main board whence it originates. It will assume the main board’s character not only in its behaviours but also in its outlook on business. For example, it is reasonable to consider whether a board is ‘investor-driven’ or ‘strategy-led’, as defined by the previous 2005 PARC/CRF report on The Role of the Board. In other words, whether the board concerns itself primarily with responding to investor pressure, or setting a longer-term agenda on its own terms, will also reflect itself in the attitudes and agenda of the Remco.
RECOMMENDATIONS We see the following as practices either essential or highly desirable in promoting the effectiveness of a Remco: • The role and character of the Remuneration Committee chair is absolutely crucial, including the amount of time and the quality of the input which the chair gives to Remco matters in between formal Remco sessions, and in managing the complex web of relationships, internal and external, within which the Remco finds itself.
To what extent should the softer elements of performance – for example, the appraisal itself – be part of the Remuneration Committee remit? Most of the chairs said they discussed performance; few saw the appraisal and looked at the objectives against results, leaving this to the CEO to advise on. Some companies simply adopted the same process they would with any other valued professional group in tying commercial objectives to individual targets and structuring reward around that. One investor we spoke to simplified the remuneration process. He said the main board should debate and agree the company strategy and objectives for the year or longer, the Remuneration Committee should turn those objectives
Précis of PARC Research Report
• The Committee should comprise a healthy and complementary mix of experience and outlook; past and/or present. Interestingly, our research suggested membership of another Remco was welcomed by Remco chairs. • There should be a practical and conscious programme of continuous development for Remco members, with regular specific information or even sessions on relevant issues and events in the wider world. Executive pay packages have increased in complexity in recent years, and Remco members must be able to understand the methodologies of the compensation consultants presenting to them. • Time is a huge and increasing problem. It is useless to attempt to broaden the view
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of the Remco unless this is recognised and attended to. The Remco chair in particular needs to recognise and act upon this; it is not acceptable to delegate much of the chair’s activity (especially in relationship management) to the HR function. The issue of time does bring into question the viability of multiple nonexecutive appointments. Should such people be holding more limited portfolios of appointments, but with higher pay, to recognise the time commitment? • The Committee needs to ensure a clear and comprehensive charter with an associated set of objectives which are set and reviewed each year. The platform for this will lie in a deep understanding of the performance and competence issues which should drive pay, including the organisation’s strategic priorities and projects, and the consequent demands upon executive accountabilities and competences. • Remcos should not define their roles too narrowly. They should take a 'joined-up' approach to understanding and reviewing strategy, organisational appropriateness, quality, development and resourcing of senior talent and performance at corporate and at individual levels. This is important, because all of these issues are closely connected. Just covering reward is not sufficient to develop an informed approach to 'pay and performance'. • The Remco, usually through the chair, needs to have clear and unambiguous responsibility for the selection, briefing and management of its own advisers. In addition, it should have its own operational budget for Remco operations, including the activities of its advisers. • The Remco should operate with a clear performance focus; this should underpin all of its deliberations in executive reward. ‘Performance focus’ includes not just the
business performance of the organisation, but also the individual performance of the executives under review. Remcos should be prepared to take a lead on this including one meeting in the year which is clearly devoted to a review and discussion of performance, both externally and internally – a review of performance which is not contaminated by discussion concerning pay! • There should be proactive and clear communication with external investors – not just when there is something new and their votes are needed. • There should be an annual review of the external executive reward market and the relevant trends. This review should be independent of the internal pay discussion for executives. • There should be an annual briefing to the Remco covering the pay and benefit programmes across the company. The Remco should be mindful of the fact that they should not be considering the reward of executives ‘in a bubble’; their decisions need to be made in the context of the company at large. • The Remco needs to be aware of its possible interface and relationships with other Board committees, if there is not a total overlap of membership. Relationships with both the Audit (such as with regard to incentive arrangements) and Nominations Committees (such as with regard to senior external hires) need to be considered. • The Remco should not be afraid to take a bold and possible distinctive line for the company where this is appropriate. If differentiation is good for business strategy, how come it is not so good for executive reward? • It is important for the Remco to ensure that it spends some time on its own for a frank discussion of any issues or concerns. This
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should be without the presence of its advisers and even without the presence of other internal attendees, such as the Board chair, the CEO and HR representatives.
matters. However, we put forward the following recommendations as potentially valuable practices for the HR function to consider, almost irrespective of the precise role which they play.
• We also emphasize the importance of the Remco conducting a proper evaluation of its performance against the stated objectives. This means not only evaluating the effectiveness of programmes which it has installed (and Long-Term Incentive Plans in particular merit close evaluation in terms of effectiveness and value for money), but also in terms of its functioning as a body (Likierman, 2006).
RECOMMENDATIONS • The HR function should be the internal source of expert knowledge of external trends and market data upon which the Remco can draw. • HR should be the source of expertise and ‘role model’ for a performance focus, able to speak knowledgeably on the performance context of market data presented to the Remco and acting as the resident experts on the skills and processes of performance management. HR cannot fully carry out this role as respected adviser unless it is an integral part of the company’s strategy formulation and performance management processes.
3.3 The Role of the HR Function In our field research the question of the role of HR in the Remco process came up as a frequent topic in the various discussions with all parties. There was a wide range of opinion, ranging from the view that HR could not realistically be asked to be independent enough to support the Remco, to the totally opposite view whereby HR should have/actually had enormous influence on the work and decisions of the Remco. Our view is that it is the quality of the reward specialist and the relationship they form with the CEO and Remco chairman that determines the overall effectiveness, and that the chairman should probably try to determine how this triangular relationship actually works. As ever, it may be surmised that the characters of the HR Director and the Remco chair are critical variables in this equation. It is hard to say that there is one right approach for HR to take in these
Précis of PARC Research Report
• Senior members of the function, and primarily the HR director and the remuneration and benefits director, should be freely available to the Remco chair and to the individual Remco members for consultation and advice. • HR should be in a position to support the external advisers and ensure that they are properly briefed and chartered. However, they should not seek to influence the advisers unduly. The best consultants give of their best when they are so managed, and not the victim of a client who tries to use them as a mouthpiece. • HR should promote and safeguard the interface of executive reward programmes with what is on offer for all employees across the company. Executive reward needs to be in harmony with the overall ‘brand’ and HR approach across the
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organisation. Employees at large will see (and also hear!) about senior executive reward in their organisation. Human resources managers can help to ensure that there is a coherent message and that senior executive reward does not serve as a de-motivator to the rest of the organisation.
orchestrators of consultation between key parties concerning proposals and papers before they reach the Remco, for example, the design and installation of new incentive plans. This is not the job of external advisers and the Remco chair may not have the time available to pursue all aspects of this.
• The expectations and reactions of the senior executives themselves to their reward programmes need to be monitored by HR in support of the Remco chair.
• HR should be leading the measurement and evaluation of the effectiveness of the senior executive reward programmes which the Remco put in place; in particular the impact of incentive plans, both short and long term.
• HR
should
be
the
facilitators
and
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