Five principles on setting executive pay

13, Dec 2012

If you’re feeling under siege from the 2012 ‘Shareholder Spring’, let our five pay principles help guide you through the executive remuneration storm. 

When setting or reviewing executive pay your Remuneration Committee should have in mind these core pay principles:

 

1. Visibility of achievement

How clearly can investors see the achievement of your senior executives? Enhanced share price is a perfect reward for shareholders but an imperfect measure of performance. Can you translate the executives' achievements into shareholder value and articulate it to investors? There is currently a lot of emphasis on measuring and evaluating senior pay but little attention is paid to the credit balance, ie, the achievements of executives. It is time to redress this balance. 

2. Linking performance targets to the business plan

Are your executives – and your shareholders – clear as to how performance targets are linked to the achievement of the business plan? There is now greater flexibility in designing performance targets; use this flexibility to ensure that the achievement of the targets adds value to your business.

3. How much are you paying for success?

If all the targets are achieved next year, how much will the top executives receive? Most companies can’t answer that question because some of the reward hinges on an unascertainable amount, as it is dependent on share price fluctuations. The unpredictability aligns management to shareholders and is not objectionable per se. But, the return is usually uncapped – management will get their full shareholding if they meet their targets – even if the share price has soared. This can put a significant financial burden on the company. One way of controlling executive pay is to cap the returns from their long-term incentives.

4. Clarity – communicate regularly on progress

In order to be effective, executives should have a clear picture of whether or not they are achieving their targets. Do executives get information on their progress as often as the company publishes financial data? If not, how can they measure their performance and adapt their behaviours accordingly? For incentives to work, it is essential that they are 'live'; this means progress should be communicated regularly and well.

5. Simple = costly

Often the call goes up for simplicity, and the lengths that companies go to achieve it are very costly. Carefully evaluating expense and taking a flexible approach to structure can result in significant cost savings for both companies and executives. Remuneration Committees should not shy away from creative ideas to deliver reward.

 

Pay issues are already high profile and have high-risk implications for the employer. If it can actively address the principles above, your Remuneration Committee would be in a robust position to explain its approach to pay. Putting forward a directors' remuneration report that is 'below the radar' is no longer an acceptable strategy for a credible Remuneration Committee.

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