Remuneration of Directors

Remuneration of Directors

Case Study:

In early 2013, the remuneration committee of Boom Co (a listed company) met to determine the rewards for the executive directors. It was the practice of the committee to meet annually to decide on executive rewards for the forthcoming financial year. In line with best practice, the committee was made up entirely of non-executive directors.

When the remuneration committee met, its chairman, Sarah Umm, reminded those present that the committee should comply with the guidance of the relevant code of corporate governance. She read out the section that she believed was most relevant to their discussions.

‘A significant proportion of executive directors’ remuneration should be structured so as to link rewards to corporate and individual performance. The remuneration committee should judge where to position their company relative to other companies. But they should use such comparisons with caution in view of the risk of an upward movement of remuneration levels with no corresponding improvement in performance. Remuneration for non-executive directors should not include share options or other performance-related elements.’

She explained that the committee should balance several concerns when setting rewards: the link with performance, market rates and the company’s overall strategy. The strategic priority in the next few years, she explained, was to incentivise medium to long-term growth whilst retaining the existing executive board in place as long as possible.

At the end of the meeting, a new member of the committee, Sam South, asked whether there were any performance-related elements of non-executive directors’ rewards. Sarah Umm explained that these were only available to executive members of the board in line with the terms of the corporate governance code.

Required : 

Task (1) Distinguish between the concepts of Social Responsibility Accounting (SRA ) andCorporate Governance (CG)

Task (2) Explain what is meant by a ‘code of corporate governance’ and discuss the general purposes of such a code in listed companies such as Boom Co.

Task (3) Propose how the components of a reward package might be balanced to ‘incentivise medium to long-term growth whilst retaining the existing executive board in place as long as possible.’

Task (4) Briefly explain the general roles of non-executive directors in a listed company such as Boom Co, and discuss why non-executive directors should not receive performance-related elements in their rewards as Sam South enquired.

*constructions and format of the assignment  :- 

• introduction ( 100 words )
• tasks answers :

1. Task 1 ( Maximum 150 words )
2. Task 2 ( Maximum 150 words )
3. task 3 ( Maximum 150 words )
4. task 4 ( Maximum 150 words )

• Limitations ( 100 words )
• conclusion ( 100  words )
• references

* support your assignment with relevant graphs, charts, tables( quantitative data) if applicable

* Maximum  words of assignment =  850 words 

Notes :- 

in the case of task (1), you should draw a table to distinguish between (SRA ) and (CG) . However , the answer of Task (2,3,4 ) is provided and just paraphrase and summarize them to 150 words .

• Answer of Task (2) 

Codes of corporate governance

A code (of corporate governance) is a document that specifies certain standards, principles, norms of behaviour or specific instructions over matters of corporate governance.

Some have evolved over time as different previous reports were written for different aspects of governance, which were then brought together in combined codes. Others have borrowed from existing codes, perhaps amended slightly to account for national differences.

Codes of corporate governance are issued by regulatory authorities (such as stock exchanges, governments or semi-autonomous government bodies) and are statements of general principles and detailed guidelines on many matters of corporate governance. They can be implemented either as listing rules (in principles-based jurisdictions) or in law (in rules-based jurisdictions).

They typically cover all relevant aspects of corporate governance including the roles of the board, risk management, internal controls, executive remuneration and contracts, reporting issues and similar relevant themes. The purpose is to ensure that companies are well-run and in line with shareholders’ interests.

The purposes of such codes are as follows:

First, they guide and specify behaviour in matters of governance, internal control and risk management with the objective that by complying with the code, corporate governance will be improved and enhanced.

Second, they aim to encourage best practice and to improve management performance by preventing practice that might reduce value added or shareholder value.

Third, codes aim to underpin investor confidence in that high levels of compliance tend to be appreciated by shareholders and poor levels of compliance are sometimes punished. It enables boards to demonstrate the value they place upon the agency relationship and to more adequately discharge the agency responsibilities placed upon them.

Fourth, codes aim to reduce fraud, waste or inefficiency. One of the main causes of the development of codes (for example in the UK and in the USA) was in response to high-profile frauds, and it was hoped at the time that codes would address this.

Fifth, in principles-based jurisdictions, the implementation of codes is thought to be a way of reducing the chances of governmental legislation being implemented. Governments are more likely to legislate where other regulatory failure is evident and so an effective code applied as listing rules should (many hope and believe) reduce the likelihood of having inflexible laws applied.

• Answer of Task (3) 

Components of reward package

Sarah Umm told the remuneration committee that the rewards should be linked strongly with the company’s strategy and that these strategic priorities were to ‘incentivise medium to long-term growth whilst retaining the existing executive board as long as possible.’

The retention of the existing board will be aided by providing a basic salary that meets market rate with in-kind benefits commensurate with the role. This is to ensure that the director is satisfied, and believes himself or herself to be fairly rewarded, regardless of performance in the role.

Retention can be helped by the payment of one or more loyalty bonuses for staying more than an agreed time period. Again, these would be regardless of performance and intended solely to reward loyalty.

These may not necessarily be monetary rewards. It may be, for example, that a director receives a car upgrade or additional days paid holiday after the agreed time period.

The incentivisation of medium to long-term performance will require the use of reward components such as performance bonuses and share options. Performance bonuses can be included for achieving certain targets in alignment with strategy.

The dates on which these are paid can reflect the time-element of the incentivisation. Sarah Umm wants to incentivise medium to long-term performance, so this is likely to refer to years rather than months.

In addition, the package could include share options which can be exercised after a number of years. These enable directors to benefit directly from increases in share value and because this is often a longer-term effect, share options may be designed to come into effect after, say, three years.

• Answer of Task (4) 

General roles of non-executive directors (NEDs)

The four general roles of NEDs are: the strategy role, scrutinising role, risk role and the people role. In the strategy role, NEDs may challenge any aspect of strategy they see fit and offer advice or input to help to develop successful strategy. The scrutinising or performance role is where the NEDs’ independence is perhaps the most important.

NEDs are required to hold executive colleagues to account for decisions taken and company performance. In this respect, they are required to represent the shareholders’ interests against any vested interests or short-term executive pressures.

The risk role involves NEDs ensuring the company has an adequate system of internal controls and systems of risk management in place.
Finally, in the people role, NEDs oversee a range of responsibilities with regard to the management of the executive members of the board. This typically involves issues concerning appointments and remuneration, but might also involve contractual or disciplinary issues, and succession planning.

NEDs and performance-related elements

The main reason why NEDs are usually not allowed to receive share options or other performance-related elements as part of their reward packages (as Sam South asked) is because it could threaten their independence and hence their usefulness to the company’s shareholders.

Whereas executive directors may, for example, be incentivised to take excessive risks to maximise their own rewards, a non-executive, without the performance-related element, will have no such incentive and will be likely to take a more objective view of the strategy being discussed.

In order to be effective in their roles, NEDs need to be motivated in different ways to their executive colleagues and too much similarity can mean that the scrutiny role is weakened. If both executive and non-executive directors are similarly motivated, there will be less scrutiny of proposed strategies for wider impacts, risks, complications and stakeholder impacts, because there will be no-one incentivised to exercise effective scrutiny.

If they received a similar mix of rewards to executives, they would be motivated to act in similar ways and this might involve favouring short-term measures at variance with longer-term strategic perspectives.

A concern over short-term share price movements, for example, might take the NEDs’ focus away from longer-term strategic issues and make them more concerned with maximising market value in the short term.

Because non-executives comprise the remuneration committee, it would be inappropriate for them to decide on their own rewards. It would be an abuse of the responsibility and trust invested in them by shareholders were NEDs to reward themselves too much or incentivise themselves in an inappropriate way.

Accordingly, it is usual for NEDs to be paid a fair rate based on external comparison figures (often a daily rate or similar) so that there is no question of it being seen as excessive. A NED’s pay is usually a small fraction of that for executive colleagues.

Last note : please do not use external source to solve Tasks (2,3,4) and just use the answer that is provided and paraphrase and summarize , but in task (1) solve it by yourself

Answer Preview

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