Remuneration

Question 1

Provide 5 reasons why remuneration is a CG issue?

Answer 1

1. Companies need to attract and retain talented executives.
2. Remuneration incentives can be used to motivate executives to achieve better results for the company.
3. Those incentives need to be aligned with the interests of shareholders and promote the success of the company
4. Directors should not be rewarded for failure.
5. Directors should not be able to decide or influence their own remuneration.

Question 2

List 5 difficulties that might arise when linking reward to performance

Answer 2

1. Selecting the right performance measures
2. Ensuring that the targets used for short-term incentives like the annual bonus promote the long-term success of the company
3. Ensuring that the targets used for incentive schemes do not promote bad behaviour
4. Preventing executives who did not perform well from piggy-backing on the success of their colleagues
5. Designing a scheme that will be satisfactory to shareholders

Question 3

Provide 3 drawbacks of using a share option scheme as part of a remuneration package

Answer 3

1. Share options reward holders for increases in the share price, when this may not always relate to the executives, or indeed the company’s performance (ie ‘Bull’ market )
2. When the stock markets are in a bear run and prices are declining, share options lose value, and may even become worthless, irrespective of executives or company’s performance.
3. The market price of a company’s shares may fall below the exercise price for its share options (‘Underwater’)

Question 4

What are the rules relating to the remuneration policy of a quoted company

Answer 4

• The annual remuneration report of a quoted company must be put to an annual vote by shareholders at the general meeting at which its report and accounts are laid (usually the AGM) (CA2006, s. 439).
• If the resolution is defeated, the directors must put the existing directors’ remuneration policy or a revised policy to a vote at the next meeting at which accounts are laid, if they have not already done so earlier (CA2006, s. 439A(2)).
• A quoted company cannot make any payments to a director unless they
  are consistent with the latest policy approved by shareholders or the payment has been specifically approved by shareholders (CA2006, ss. 226A and 226B).
• The directors must invite shareholders to approve their policy at least once every three years whether or not it has been revised and must obtain shareholder approval for any revised policy before they can make any payments under that new policy. (CA2006, s. 439A)
• If the annual advisory vote on the directors’ remuneration report is defeated, the directors must put the directors’ remuneration policy (which could be a new policy or the existing policy) to a vote either at the next meeting at which accounts are laid or an earlier meeting (CA2006, s. 439A).
• The policy that shareholders are invited to approve must be a policy that has been approved by the directors either as part of the directors’ remuneration report or separately as a revised policy (CA2006, s. 422A).

Question 5

Explain the principles of malus and clawback

Answer 5

• Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes. They should also include provisions that would enable the company to recover and/or withold sums or share awards and specify the circumstances in which it would be appropriate to do so.
  Provision 37, UKCG code
• ‘malus’ provisions allow the company, in specified circumstances, to forfeit all or part of a bonus or long-term incentive award before it has vested and been paid (also known as ‘performance adjustment’); and
• ‘clawback’ provisions allow the company to recover sums already paid.
• the current market standard triggers for malus and clawback are gross misconduct or misstatement of results (Investment Association’s Principles, Nov 2020)

Question 6

List measurements of performance

Answer 6

Earnings Per Share (EPS)
Total Shareholder Return (TSR) Share price & Dividend
Profit PBIT or EBITDA
Return on Capital Employed (ROCE)
Others (including Non Financial)

Question 7

What are the two elements Remuneration can be divided into:

Answer 7

Fixed (Regardless of performance)
Basic Salary
Pension scheme payments

Variable (Performance based)
Bonus (short-term incentive)
Share options and other long-term incentive schemes (long-term performance)

Question 8

Issues for Remuneration consultants

Answer 8

1. May have conflicts of interest by virtue of the fact they are also engaged by the executives to advise the company on other aspects of remuneration or may have another connection with an individual director (e.g. an executive director who serves on another company’s remuneration committee).
2. There is a risk that they will make recommendations which favour the executive directors and are not necessarily in the best interests of the company.
3. May be inclined to recommend complex remuneration schemes in order to increase their fees and make it more difficult for the remuneration committee to dispense with their services in future years.
4. May put pressure on the remuneration committee to accept their advice (e.g. by failing to come up with any credible alternative).
5. Executive directors and senior management may also put pressure on the remuneration committee

Question 9

What did does the CA2006 state regarding compensation for loss of office?

Answer 9

CA2006 introduced a new legal threshold for directors’ service contracts which now states that they must not exceed two years’ duration without shareholder approval, compared to five years before (s. 188).

Question 10

Give examples of circumstances where the remuneration committee should exercise discretion to revise an executive director’s remuneration downwards.

Answer 10

Mis-statement of company results
* Where the prices of the company’s product (eg commodity prices) have increased substantially leading to substantially increased profits which cannot be said to be the result of the executive’s performance.

• An exceptional event which results in a substantial positive change for
  the company, for example a change in the law.
• The successful outcome of long-running litigation resulting in a large
  award to the company.
• An acquisition of another business which was not catered for in the
  remuneration policy and which has resulted in a large increase in the
  group’s earnings.