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November 22, 2009

The Crucial Issue of Board Level Compensation- Emerging Regulatory Framework

Things are changing fast in an area traditionally shrouded in confidentiality. The issue has raise its head in the afternmath of the financial crisis. As directors give direction to the company's growth trajectory, along with senior management, they play a critical role in the future performance of a company. And they are paid heftily for such action. some such ambitious actions have landed many banks and FIs in trouble in recent times. Therefore, the financial crisis of has brought to the fore a number of policies governing director and executive remuneration.

Some Issues in Board Level Remuneration

Need for Remuneration Policy

Whilst the form, structure and level of directors' remuneration continue to be matters primarily falling within the competence of companies, their shareholders and, where applicable, employee representatives, the Commission considers that there is a need for additional principles regarding the structure of directors’ remuneration, as set out in a company’s remuneration policy and the process of determining remuneration and control on that process.

o The Structure of Director's Remuneration

The structure of directors´ remuneration should promote the long term sustainability of the company and ensure that remuneration is based on performance. Variable components of remuneration should therefore be linked to predetermined and measurable performance criteria, including criteria of a non-financial nature. Limits should be set on the variable components of remuneration. Significant variable components of remuneration should be deferred for a certain period, for example three to five years, subject to performance conditions. Further, companies should be able to reclaim variable components of remuneration that were paid on the basis of data,which proved to be manifestly misstated.
o
Termination Payments under Scanner now

It is necessary to ensure that termination payments, so-called ´golden parachutes´, are not a reward for failure and that the primary purpose of termination payments as a
safety net in case of early termination of the contract is respected. To that purpose, termination payments should be limited to a certain amount or duration beforehand, which, in general, should not be more than two years annual remuneration (on the basis of only the non- variable component of the annual remuneration) and not be paid if the termination is due to inadequate performance or if a director leaves on his own account. This does not preclude termination payments in situations of early termination of the contract, due to changes in the strategy of the company or in merger and/or takeover situations.
o
Remuneration in Shares

Schemes under which directors are remunerated in shares, share options or any other right to acquire shares or be remunerated on the basis of share price movements should be better linked to performance and long term value creation of the company. Therefore, an appropriate vesting period should apply to shares, whereby vesting is made subject to performance conditions. Share options and rights to acquire shares or be remunerated on the basis of share price movements should be not be exercisable during an appropriate period and the right to exercise them should be made subject to performance conditions. In order to further prevent conflicts of interest of directors who hold shares in the company, these directors should be obliged to retain a part of their shares until the end of their mandate.
o
Towards Greater Transperancy

In order to facilitate the shareholders' assessment of the company's approach to remuneration and strengthen the company's accountability towards its shareholders, the remuneration statement should be clear and easily understandable. Moreover, further disclosure of information relating to the structure of remuneration is necessary. In order to increase accountability, shareholders should be encouraged to attend general meetings and make considered use of their voting rights. In particular, institutional shareholders should take a leading role in the context of ensuring increased accountability of boards with regard to remuneration issues.
o
Role Of Remuneration Committee

Remuneration committees, as referred to in Recommendation 2005/162/EC, fulfil an important role in designing a company's remuneration policy, preventing conflicts of interests and supervising the (managing) boards behaviour in the context of remuneration. To strengthen the role of those committees, at least one member thereof should have expertise in the field of remuneration.
o
Exercise Caution in Hiring Remuneration Consultants

Remuneration consultants may have conflicting interests, for instance when they advise the remuneration committee on remuneration practices and arrangements, and at the same time advise the company or the executive or managing director(s). It is appropriate for remuneration committees to exercise caution when hiring remuneration
consultants.

Posted by sunandoroy at November 22, 2009 02:36 PM