PAY MANAGEMENT PROCESSES IN UK COMPANIES

In broad terms, the UK 'unitary' board typically manages its own pay along the following lines:

§  Responsibility for the pay of the executive directors is delegated to the remuneration committee (to be formed of at least three independent, non-executive directors), which will make its annual recommendations to the board.

§  The pay of the non-executive directors is usually managed by the chairman, perhaps in conjunction with the chief executive, who will also make recommendations to the board (often less frequently than annually).

§  The board as a whole votes on these pay recommendations but no director is able to vote on his or her own pay.

§  Shareholders have the opportunity annually to vote on the acceptability of the remuneration committee's report on boardroom pay in the company's report and accounts and to vote to approve (or otherwise) any new long-term incentive schemes for the board or that involve the issue of new shares or the transfer of treasury shares.

The impact of the annual vote of the remuneration committee's report is purely advisory but most boards seek to achieve high levels of shareholder approval - the disapproval of a small but significant minority of shareholders can be very damaging to the company's reputation and, if not addressed, can jeopardize the remuneration committee chairman's position.

Executive Directors' Pay

The principles (outlined in the Greenbury Report) that should underpin the recommendations of remuneration committees concerning executive directors' pay are that:

§  basic salaries should be maintained at a level that allows the company to compete effectively for good-calibre executives;

§  annual pay increases (if any) should be awarded in relation to performance and an assessment of market competitiveness from one or more reputable sources;

§  the basis, targets and payments from executive incentive schemes should serve the needs of the business and be satisfactory to shareholders in both the short and the longer term;

§  the balance between the elements of pay and benefits should be maintained on a sensible, competitive and defensible basis;

§  relationships between boardroom pay and that of employees at a more junior level should remain consistent and sensible;

§  in addition, directors contracts should be reviewed from time to time to ensure they remain up to date and defensible (eg notice periods should be 12 months or less).

In applying these principles the remuneration committee should seek proper, professional and, where appropriate, independent external advice.

The 2003 Higgs Review suggested that boards should adopt a process whereby the performance of individual directors, as well as the board as a whole, should be assessed each year. The results of this process clearly should be used to support the work of the remuneration committee.

Non-executive Directors' Pay

The pay for non-executive directors (again from Greenbury) should:

§  provide a reasonable recompense for the time and commitment a non-executive director contributes to board meetings (ie reflecting the role undertaken, time commitment required, committee and other responsibilities taken on, the company's size and the individual's unique skills/reputation);

§  not be so large or so structured (eg by participating in any incentive scheme or having a company car) as to jeopardize the non-executive director's independence.

In response to the second condition, many companies pay non-executive directors purely in cash but now some allow or even require their non-executive directors to take some or all of their fees in the form of the company's shares.

In the introduction to his 2003 review, Sir Derek Higgs observed that, 'Too often the governance discussion has been shrill and narrowly focused on executive pay with insufficient attention to the real drivers of corporate success. It would represent progress if this Review were to open a richer seam of discussion, one with board performance and effectiveness at the core.' Although the spotlight seems very unlikely to move away from directors' pay, it does seem that the press and boards themselves increasingly recognize the need for a clear link between pay and performance at board level and that 'payments for failure' (large pay-offs to directors leaving as a result of poor performance) will be much more difficult to make in the future.