Sean O’Hare: Inside RemComs
This week we welcomed Sean O’Hare to our breakfast event to discuss The Remuneration Committee.
The UK Corporate Governance Code has 2 pages in Section D on what RemCos do, and most other governance codes cover something similar. Sean would really recommend ANY NED of FTSE listed companies to read it.
The FRC has also published a Guide on Board Effectiveness which defines the roles of Chair, CEO, NED and Senior Independent Director and what is expected of each role. This code is very straightforward. The Remco must:
- Set the remuneration for the Executive Director and Chairman and
- Promote the long term interests of the company
When other elements are covered, this is the choice of the board
On most PLCs the CEO and FD monitor pay for the senior management and simply informs the RemCo. A conflict arises for the RemCo when it has to set the fees of the chairman and the execs and also monitors pay for senior management, while in turn, the NED fees are set by those management sitting on the board and the chairman. Which get set first? It tends to be a moving dance.
Who sets exec pay below board level? It can be the first area of tension. You should check how the mechanics work. It is very important to look at the terms of reference to see who is included in the remit. You need to have a real understanding of your CEO.
The basic structure for RemCo to consider is:
Base pay, ltip, benefits, pension, bonus … which do you cover? Check the rest to see if you should cover them. Don’t forget to consider benefits. RemCos have been caught out by not looking at benefits and discovering too late, that they are inappropriate.
If you are part of a large company you need to work out the right incentive measures. This can be hard.
Incentives that drive the business forward are required but you need to exercise judgement about what stage the business is at, what’s needed in good times .. why is it good? Consideration needs to be given to what’s management execution and what’s windfall.
If you are in “survival times”, will there be lay-offs? Remuneration might come down. However, sometimes, during times of change pay might increase to keep a strong team.
The makeup of the RemCo
In theory there should be 3 people on a RemCo (the independent NEDs, without the chair). However, the room can become very crowded once you add the Chair, the CEO, the HR Director, GC, company secretary, external advisor etc. They are often present in all meetings.
It can be very difficult to make decisions in a crowded room so it is essential that private sessions take place before the committee meeting takes place. If adjustments need to be made to the CEO’s pay then the Chair of RemCo and the board Chair need to manage delivering that message to the CEO over months, usually leading up to year end.
How much are decisions affected by competitor analysis? Plenty, but this is often a criticism as companies can then be seen as a closed shop. Retention issues are key here. Succession plans are also important – payouts vs retention rewards.
Management will also talk about flight risk in which case it is worth talking to headhunters.
Again the analysis will depend on time, longevity of staff, no. of successors etc.
Generally, if the chair of the RemCo has tested his pay ideas beforehand it is rare for him to need to ask the chief exec to leave the room. CEO pay is usually decided during on-going negotiations off-line. However, increasingly RemCos are holding private sessions without management. If this is done as standard practice then it shouldn’t be an issue for the CEO. It is, however, important for the chair of the meeting to brief the CEO on the outcome. Rarely do the RemCos vote, so the outcome is a conclusion of a discussion acknowledged by the RemCo members.
The public sector is different due the the 1% pay cap across the team. Even though you are dealing with less money, the outcome is almost more important because of that. The cash makes more difference to the recipients.
A lot of RemCos like formulas, or a balanced score card, which can be easier since they are less emotive. But RemCos need to look at whether a formula approach is appropriate. You should be influenced by other factors too e.g if deaths in mines increase how should that affect the CEO pay?
The High Pay centre website has some interesting research, although it is less firm on rationale for conclusions.
Rem used to be simply old fashioned base pay plus a bonus, basically a profit share. The introduction of incentives by consultants was meant to change behaviours. In reporting on Rem, this distinction is lost. Most executives are not motivated to act differently because of an incentive unless it is specifically focussed. It will depend too on whether the individuals are risk takers.
Evidence shows that candidates recruited externally perform worse and stay for a shorter time than internally recruited candidates. This should perhaps affect pay.
In listed companies, remember 60% of the package is regularly in long term incentive plans, much of which is market driven.
It is important to understand what your role is and what the vested interests of the participants of the committee are. It can get emotive.
RemCos are getting more involved in the judgement of performance, which is meant to be the remit of NomCom.
Reputation is not discussed enough at RemCos – too much is process. RemCos should consider the reputational risk of decisions made in the committee.
- Reputation involves the press, but also remember
- Reputation to the employees who will be the first to look at the REM report when it goes on line!
In summary RemCo is the most exciting committee to be on. You get to see human behaviour in the raw and it gives a clear indication of the relationship between chairman and CEO. Does the chairman always support the CEO?
What positive reasons are there for a lawyers to be part of a RemCo? You can keep them safe but also be pragmatic.