Don’t blame the CEO – it’s the Remuneration Committees that set pay

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Don’t blame the CEO – it’s the Remuneration Committees that set pay

CEOs get the rap when it comes to their pay levels, but Louise Chaplin, Partner and Head of Board Practice at Eton Bridge Partners, argues that more considered skill set definition and selection processes for independent non-executive director (NED) appointments could make for smoother investor relations:

Anyone who watched the toe-curling moment Jeff Fairburn, boss of construction firm Persimmon, tore off his microphone and sulked off mid-flow when asked by a BBC journalist about his £75million bonus, will have no-doubt wondered just how it is that this particular boss’s reward came to be so grossly out of kilter with what the rest of his peers pocket.

I can’t blame you if you did. We live at a time of heightened sensitivity to so-called greedy, fat cat bosses. Already the average FTSE CEO earns 386 times more than the people they employ – and accusations of grandiose pay comes hot on the heels of the recent collapse of Carillion, where a perceived lack of vigilance over audits, balance sheet understanding and integrity, stress-testing of cash flows and executive salaries/bonuses were all cited as poor oversight areas that contributed to its downfall.

Not surprisingly, both events have seen increased media scrutiny on the topic of company governance, and in particular amongst the people who actually impact it – a firm’s remuneration committee, led entirely by the independent NEDs. Typically though, one key question tends to remain unanswered: whether there really is sufficient governance around executive remuneration in line with business expectations. It shouldn’t be this way though – which is why I recently spoke to an expert on the matter myself – James Dewar, an independent NED, audit committee chair and remuneration committee member who has worked with a number of listed and privately owned companies over many years.

So what does he have to say? Perhaps unsurprisingly, James is of the opinion that a disproportionate amount of media attention is now aimed at maybe the 10% of any annual report’s content that is concerned with directors’ remuneration. He also questions the merit of headline-grabbing, and arguably crude CEO pay ratios that can become particularly meaningless, he argues, if one firm has a large workforce of manual labourers, for example, and a small management team. The tail, he says, could be wagging the dog!

But does this mean nothing should ever change, or that no improvements can possibly be made when it comes to hiring future board members?

Of course not. The one thing that’s certain is that the annual report is an ever-changing beast, and so the board members that are hired to produce them also need to prove they’ve maintained their skills accordingly. A relatively new requirement, for example, is the production of a ‘viability statement’. This is a director approved document within the annual report, where the company board in question confirms the reasonable expectation that it can continue to operate and meet its liabilities, as they fall due, over the next three-years. Crucially, these pronouncements can’t just be guesstimates. They need to be properly underpinned by board supported cash flow projections, which are also stress-tested against a range of downside scenarios. In short, it’s no good later saying that certain revenue or cost assumptions didn’t pan out as expected.

It is the combined view of James and I that organisations can think deeper about getting the right NED talent to manage the increasing agenda of the board and the board committees. We consider that in the search processes, it is important to look for certain key qualities when appointing any NED for the audit committee or the remuneration committee:

  1. Qualifications: For the audit committee, at least one member should be a qualified accountant, able to have relevant, technical conversations with the CFO and the external auditors to understand the key accounting judgments being made and then inform the board. For chairs of the remuneration committee, we recommend the presence of previous HRDs, or those with a Group General Counsel background in HR legal matters.
  2. Decision-making skills: Any independent NED needs to be willing to take tough decisions where necessary and be transparent to the board and to shareholders. The audit committee chair, together with the CFO and the board, needs to make sure they issue a set of financial statements that have integrity, reflecting any adjustments or impairments required in that year. Similarly, the remuneration committee chair needs to ensure that executive bonus targets are fair and reasonable and that year end assessments are evaluated with rigour and appropriate judgement to reflect actual performance.
  3. Those appointed must have the time: NEDs typically sign contracts committing them to a certain number of days a year. This should be considered the minimum Any independent NED must have the time and the space to be able to devote additional time as required, for normal business, or for a crisis. Appointments to boards absolutely need those NEDs that do have the time.
  4. Ability to recognise where independent, external expertise is needed: There are likely to be occasions where the board or the board committees will need to seek external input to inform their decision making. The ability to recognise “when” and “from whom” is an important quality for an independent NED.

It stands to reason that NED support must include strong systems of internal control, defined repeatable internal processes, clear accounting policies and procedures, plus high quality and timely management information. And yes, the executive search firms need to play an important part in the recruitment process. When boards need to recruit a new independent NED, or audit or remuneration committee chair, the selected search firm should have the expertise to know precisely where and what to look for to acquire the skills and experience needed for the board and board committee rooms.

The fewer future Persimmons interviews we see, the better!