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  Problems with the Process

Introduction to Problems with the Process

Various studies have pointed out problems in the way in which remuneration committees operate. One study by Main and others interviewed 22 independent non-executive directors with experience of remuneration committees and found that the businesses for which they served held, on average, 4.8 committee meetings every year. These meetings were tightly planned and frequently fairly brief (on average 1.5 hours). Despite the significance of their role, it seems that these committees do not devote much time to carrying it out. The study also found that it was quite common for the chief executive officer (CEO) and chairman to be present at remuneration committee meetings.

It seems that committee members are rarely selected on the basis of their experience in negotiating or developing reward packages or given training in these matters once appointed. This can be a particular problem when hiring a new chief executive officer. The pool of talent for chief executives is small and it is a 'seller's market'. Thus, to recruit a suitable candidate, the committee may be tempted to offer more than is necessary. Incumbent chief executive officers may also be over-rewarded. They are frequently powerful personalities with considerable affect over other board members. There is a danger that committee members will be too deferential and will err on the side of generosity in contract negotiations.

More problems occur from the process through which remuneration schemes for directors are developed. The committee is frequently not responsible for the initial development of these packages; the time spent through non-executive directors on committee meetings is just not long enough. In its place, the human resource department will frequently gather data from within the business and commission market data from outside remuneration consultants. Proposals will be produced, which may then be sent to the chief executive officer and other senior directors for approval. After this has been done, they may be passed to the remuneration committee for consideration. Jenson and Murphy make the point that 'The fact that the committee only sees plans that have already been "blessed" by top managers creates an environment that invites abuse and bias.'

The remuneration committee must be careful when using market data to formulate appropriate reward packages. Too great a focus on trends of market and statistics has been held responsible, minimum in part, for a ratcheting effect on directors' rewards. Such data can often be used to justify an increase in rewards: usually businesses do not want to be seen paying below-average rewards to directors. This can result in upward pressure on the average level of rewards without a corresponding increase in performance.

  • Improving the process

A strong chairman is very important for promoting the integrity and independence of the remuneration committee. The chairman should fix the agenda and should attempt to make sure that the committee has the chance for open discussions without other directors being in attendance. The chairman should also attempt to make sure that the committee has access to suitable information and expertise.

The remuneration committee should obtain direct responsibility for crafting reward packages for directors. For this, committee members must spend time and effort in performing their role and sufficient training must be provided. To assist to stiffen the resolve of committee members, regular meetings along with shareholders should be arranged.

It is improper for the human resources department, in conjunction with outside consultants, to ready reward packages for the remuneration committee just to rubber stamp. It is also not proper for the chief executive officer and chairman to support these packages before they are passed to the remuneration committee.

Non-executive directors                                                              

Planning a remuneration committee does not deal with the problem of which determines the pay of the non-executive directors.

Reporting directors' remuneration

The law needs that UK listed companies ready an annual directors' remuneration report. This report has to be submitted to shareholders for approval, which will generally occur at the annual general meeting. The report should start the remuneration of each director along with details of salaries and other advantages received. The chairman of the remuneration committee will generally attend the shareholders' meeting to deal with any matters that may arise.

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