The introduction of executive remuneration disclosure requirements, shareholder voting on the remuneration report and the sensitivity of pay issues in a savagely declining market have thrust remuneration committees into the spotlight and placed them under unprecedented scrutiny by shareholders and investor groups.

The best of these committees are seeking to transform themselves from a relatively low-key and reactive role to being initiators of changes in policies to support the business and anticipate its challenges and future needs.

As a guide, in this article we present our observations on the best remuneration committees. These observations can be used as a checklist for assessing the performance of your own committee.

The best remuneration committees are proactive: they recognise and address the growing burden of regulatory requirements, but maintain an appropriate focus on the direction and needs of the business and on developing the supporting remuneration strategy. They manage potentially contentious issues to avoid unnecessary controversy and recognise the need to provide investors and proxy firms with an understanding of the rationale for various policy initiatives. Communication is pre-emptive, rather than reactive.

The best remuneration committees are prepared to deviate from the accepted norm: although adopting policies that reflect “standard market practice” may be non-controversial, effective committees understand that ‘best practice’ may not be appropriate to the company’s circumstances and culture, and may compromise an opportunity for it to gain competitive advantage. However, as previously mentioned, they also understand that they need to clearly explain the rationale for decisions that challenge the prevailing wisdom.

The best remuneration committees are prepared to differentiate performance: good committees challenge “one size fits all” approaches and ensure that key executives and high potential individuals are being appropriately rewarded, developed and subject to arrangements that reinforce the prospects for their retention in the business. Although it is appropriate to consider both internal and external candidates, studies have shown that the availability of well-prepared internal candidates can reduce risk and possibly improve performance, as well as being more cost-effective, as reported in previous newsletters [for example, see HERE; and HERE].

The best remuneration committees ensure legitimate pay-for-performance structures are in place: committees need to be aware of the company’s performance relative to others in the industry, based on profits, risk and returns, and to be focussed on the key performance drivers that will deliver optimum long-term value to shareholders. Reviewing external equity analysts’ projections and identifying emerging deficiencies in relative performance will in part achieve this.

The analysis needs to include an assessment of the causes of inferior performance, particularly whether it is the result of management decisions or is affected by external factors outside the control of management. Importantly, rewards must be linked to performance in areas that are within management influence and control and commensurate with the quality of that performance.

Leading remuneration committees are able to avoid confrontations with management, without compromising their decisions: they do this by establishing and communicating a sound remuneration philosophy and guidelines that provide clarity about the situations in which exceptions will be made. This requires considerable skill and openness.

Leading remuneration committees seek to improve their performance and effectiveness: evaluation of their performance, review of the quality of support received from external consultants, review of new trends and developments in remuneration, monitoring changes in shareholder and investor group attitudes and assessing new and proposed regulatory developments can all help to ensure optimal effectiveness of the committee. A structured induction process for new committee members allows them to rapidly gain knowledge of the issues driving remuneration policy and practices and enables them to quickly become effective contributors to the decision-making process.

Leading committees keep the full board informed: remuneration issues, particularly those relating to executives, are often controversial. All directors need to have an understanding of the rationale for remuneration recommendations and decisions, requiring the committee chairman to communicate regularly with all board members to provide background and obtain their input. This, however, must be achieved without the committee abdicating its responsibility for oversight of remuneration issues on behalf of the full board.

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