Because they must feel that it is hard to get it right. They are coming under pressure from management teams who been out in the cold during the recession in terms of pay. With the sun emerging on the economy those management teams, understandably, are looking for some of that warmth to make its way into their pay package. Institutional investors are quick to criticise but are reluctant to engage in consultation on executive pay. And there is the constant fear of bad press – either literally, or from commentators inside and outside the company. Non-executives on remuneration committees can often be quoted as saying 'they do not want to put their head above the parapet'! Then there is the dilemma of performance linked pay: there is a fine line between paying for performance and encouraging undue risk-taking. The temptation is to identify the lowest common denominator as being the least controversial approach and to shrug their shoulders at management's objections.
But this would be unfortunate. Particularly as we are on the cusp of economic growth and we need to ensure that our pay structures support necessary improvements in productivity. Management teams need to have a clear picture of the business plan aspirations and what they will receive if these are achieved.
So where should the beleaguered Remco start? The following principles provide a good framework:
- Salary – the principle is that this should be sufficient for the executives to meet their normal living costs. Where pay has been frozen and costs rising, the Remco needs to test this proposition. This has to be done in the context of the workforce as a whole – as the same principles apply to other employees. In order to keep pay affordable, companies should try to make cost savings that don't affect the level of pay. It is worth taking a hard look at tax, commission and other costs.
- Bonus – a small basket of three or four objectives) needs to be identified, which the executives can influence and will add value. The bonus needs to be affordable, targets stretching, but not unrealistic, and include a range of potential pay outs. Common mistakes include focusing on current profit to the detriment of investment, or sales at the expense of margin. Is there a case for phasing the pay out of bonus? Perhaps claw back may be justified for malfeasance? Are you rewarding for cameo performance or sustained growth?
- Long-term incentives – every company should have at least one. Management should be focusing on generating growth for shareholders over the long-term and their personal wealth should be linked to shareholders as a result. There should be reasonable sized awards on an annual basis so that participants always have a lot to lose if they leave. Again, the reward should be affordable and can be delivered in shares or cash. If shares are awarded, being able to realise share value should be a focus, either through disposal or via a valuable dividend stream.
- Pensions – now that defined benefit schemes are largely history, there is a tendency for defined contribution arrangements to be funded by the company at around the 10% to 15% level. At executive level, it is questionable whether this is adequate. Encourage contributions by the executive by offering the facility to sacrifice bonus into their personal pension pot.
The Remco should have a clear picture of the performance targets set for both short and long-term incentives and how they fit together. Understand the cost to the company taking into account tax relief and accounting charges). The Remco also needs to ensure that it has mapped the 'what ifs' – in other words, modelled potential pay outs on a range of out-turns achieved by the company. Be prepared to articulate not only the separate components of pay but how they fit together and how this maps to the company's strategy. Comparisons with other companies are not for the purpose of spiralling pay but to understand who and how you compete with for talent in your market place. Note that this affects performance targets rather than levels of pay. Where will you need to recruit your high flyers – and what companies might lure away your current stars? How do you ensure that pay plays the right part in engaging your executives?
By ensuring that there has been a thorough process and that it has built a consensus with the stakeholders, the Remco should be in position to present a robust pay proposition. And the non-executives should be sufficiently well-armed to feel that they can go over that parapet!
This article was written by Amanda Flint, Partner at Grant Thornton UK LLP. For further information please contact Amanda Flint.
