Australian executive remuneration practice and governance has stood up relatively well in the global financial crisis.   One sign of this is international acknowledgement that APRA’s remuneration guidelines provide a model for the G20 response for the financial services sector.  Corporate practices from the US in relation to remuneration have tended to attract criticism.  But a set of recommendations and ‘guiding principles’ produced by The Conference Board Task Force on Executive Remuneration in the US recently suggest that a positive wind for change may be blowing. 

The guidelines are designed to restore credibility and increase trust in pay practices and oversight, and while not revolutionary, they provide a helpful reference point for boards, remuneration committees, management and others interested in the governance of public companies.  The Task Force report is available HERE.

The Conference Board is a global, independent business-membership and research association working in the public interest. Its mission is ‘to provide the world’s leading organisations with the practical knowledge they need to improve their performance and better serve society’. Additional information about The Conference Board is available at its website at HERE.

The Conference Board Task Force recognises that a company must have the flexibility to set and change its business strategy as its circumstances change over time and then to design unique executive compensation programmes that promote and reward achievement of the strategy objectives.  According to the Task Force, ‘one-size fits all’ rules-based approaches cannot provide the flexibility required to accommodate the disparate industries, strategies, business models and stages of development of listed companies.  Rules also cannot substitute for the good judgement required to make sound pay decisions.

The Conference Board is encouraging companies to sign up to these principles voluntarily, to demonstrate their commitment to best practice in executive compensation and pre-empt the need for stricter government regulation of executive compensation.  A number of corporations have already made this commitment.

The Conference Board guiding principles and key points made in the report in relation to each principle are set out below.

Principle 1 – Paying for the right things and paying for performance

Compensation programs should be designed to drive a company’s business strategy and objectives and create shareholder value, consistent with an acceptable risk profile and through legal and ethical means. To that end, a significant portion of pay should be incentive compensation, with payouts demonstrably tied to performance and paid only when performance can be reasonably assessed.

• It is critical that executive compensation programs link pay directly to results that help achieve the company’s business strategy, are consistent with the company’s values, and reflective of a risk profile that is appropriate in light of the company’s strategy and systemic considerations.

• Companies should be able to adjust the elements of their compensation programs from time to time as market needs and other conditions change.

Principle 2 – The ‘right’ total compensation

Total compensation should be attractive to executives, affordable for the company, proportional to the executive’s contribution, and fair to shareholders and employees, while providing payouts that are clearly aligned with actual performance.

• Fundamentally, compensation committees should determine the right level of pay for executives based on the performance of the company and individual executives.  While virtually every US company states that its compensation philosophy is designed to attract, retain and motivate the key executives required to achieve its corporate objectives (note that this is also true in Australia), committees should not pay executives more than the company can afford, proportional to the executive’s contribution, justified by company performance and what is fair to shareholders and employees.  There is no algorithm, multiple, cap, or formula that can calculate the right amount without unduly limiting the flexibility needed to compete in a global economy.

Principle 3 – Avoid controversial pay practices

Companies should avoid controversial pay practices, unless special justification is present.

• Payouts to executives without regard to performance or that inappropriately differentiate between executives and other managers can raise special risks for companies, shareholders and the overall executive compensation system because they can undermine employee morale, raise ‘red flags’ for investors, erode the company’s credibility and weaken the trust of employees, shareholders and the public.  If the board and the compensation committee decide that such practices should be used, the rationale should be clearly and plainly disclosed to shareholders. 

Principle 4 – Credible board oversight of executive compensation

Compensation committees have a critical role in restoring trust in the executive compensation setting process and should demonstrate credible oversight of executive compensation.  To effectively fulfill this role, compensation committees should be independent, experienced, and knowledgeable about the company’s business.

• The compensation committee should:

− Have access to all information relevant to the design and oversight of the company’s executive compensation programmes

− Have direct and unrestricted access to members of management who possess relevant information related to the company, and the ability to ask questions and seek further information if the committee determines that this is appropriate

− Maintain a strong dialogue with the CEO and senior management (one or more members of senior management may be assigned as primary liaisons with the committee, with responsibility for providing information necessary to or requested by the compensation committee – including human resources, legal, finance, accounting and investor relations – without self-interest or undue influence from the CEO and other members of the management team)

− Have direct and unrestricted access to external advisers who are independent of management, including the ability to engage its own advisers when appropriate

• If the compensation committee decides to engage a compensation consultant, the consultant should be selected and engaged by the committee, report directly to the committee and be independent of management.  The committee should review and approve all key terms of the engagement, including the scope of the engagement and the work to be undertaken.  All fees paid to the consultant firm and its affiliates and the consultant’s independence should be reviewed annually.  Any other work undertaken by the compensation consultant (or its affiliates) should be pre-approved by the committee and monitored to ensure it does not adversely affect the consultant’s independence.  If additional work is undertaken, the committee should disclose the fees paid for the executive compensation work and the additional work.

• There is no substitute for the independent judgement and experience of the compensation committee members e.g. compensation consultants can make recommendations on the most appropriate performance metrics, but the committee should ultimately decide the right performance targets to align with the company’s business strategy.

• The compensation committee should understand the overall employment philosophy and be involved where compensation programmes for employees other than the senior executives may pose a financial risk. 

Principle 5 – Transparent communications and increased dialogue with shareholders

Compensation programs should be transparent, understandable, and effectively communicated to shareholders. When questions arise, boards and shareholders should have meaningful dialogue about executive compensation.

• Compensation disclosures should demonstrate that the compensation committee understands the company’s business and that the metrics of the compensation programme are linked to specific measures of business performance, and should present the business goals and rationale for the performance metrics and actual payouts so that shareholders can evaluate whether compensation is actually based on performance. 

• The board and the compensation committee should work with the company to develop processes and procedures to understand investor concerns about the executive compensation programmes.

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