Section 189 of the Corporations Act, in effect, encourages directors to seek external expert opinion. With executive remuneration disclosures and remuneration report voting, most ASX 300 companies’ boards now consider some form of advice from external remuneration experts.
In establishing new working relationships with board remuneration committees we have encountered mutual surprise. On our part, we are taken aback by the low expectations some remuneration committees have of their advisers, and on some of our clients’ part they are surprised by the extent of value and new perspectives an adviser can provide. Therefore, we have put together a checklist for remuneration committees in selecting and working with an independent adviser. The checklist will be well suited to committees that recognise the need to adapt to governance trends, new shareholder expectations, additional compliance requirements, the rise of the proxy advisory firms and more complex business and capital strategies.
For those that do, this article provides a checklist for remuneration committees seeking independent advice. In doing so it also suggests how a committee could operate. What questions should a board remuneration committee have of a potential adviser? What do these questions reveal about the way the board remuneration committee operates? The following checklist can serve as a helpful starting point in assessing the fit between the committee and a prospective consultant.
1. Be clear on what you want
Committee members are usually attentive to important but routine issues related to an adviser’s reputation, expertise and his/her firm’s capabilities. However, committees’ functions and visibility have expanded as a result of new disclosure requirements, changing governance standards, and intense media attention on executive pay. It follows that the expectations and standards set for their consultants should also change, and these need to be verified before appointment.
Each committee’s requirements are likely to be different. Many still only require data. This may be the result of:
• Unusually deep director expertise on remuneration matters, or
• Trust in the nature and extent of management advice on how they should be paid, or
• A failure to recognise the extent that shareholder expectations and compliance requirements have undergone significant and recent change, or
• Deep disappointment in the standard of Australian-based advisers in the past
We suggest that given directors’ fiduciary duties, the remuneration committee consider commissioning independent external advice, rather than just data.
2. Require proactivity
Clearly, the remuneration consultant should not overstep what, by its nature, is a purely advisory role. But in guiding directors through the details of complex executive pay packages, the consultant should be willing to take, and be capable of taking, a proactive role in assuring the thoroughness and integrity of the committee’s decision-making processes.
The consultant should be able to express and argue a point of view, as should committee members. Fully discussing and reaching a consensus beforehand on both sides’ expectations and level of comfort can help ensure that the committee—and ultimately investors— get the most benefit from the relationship.
3. What is the consultant’s role in the governance process?
In the current business environment, it is increasingly necessary that an adviser accept responsibility for keeping committee members attentive to the effectiveness of their governance processes. Therefore, while the consultant should collect information and points of view from management, he/she should not be management’s advocate.
It is desirable that the remuneration committee chair be a mediator between management and the committee. The consultant, however, often needs to move the two sides off common ground if they are overlooking a key factor in their decision making.
4. Will the consultant be accessible?
The committee needs to know its consultant will be available to discuss issues when needed— and the consultant should expect the same of committee members. From the committee’s standpoint, the consultant should not be overloaded with other client work and should be reasonably available for meetings with the committee.
While a senior consultant is usually the lead person on an account, the committee should be aware of the extent to which assignments will be undertaken by a less senior person. While the latter may be competent to respond to most factual questions, the committee needs assurance that the most experienced consultant will respond when an opinion is needed regarding a particular course of action. In turn, the consultant should explain to members that doing a good job requires candour from, and accessibility to, the committee—not just when the chair requests a meeting, but also when the consultant believes there is an issue that deserves further consideration.
5. How will the consultant react when asked to take a stand?
While remuneration consultants are not decision makers, a committee is ill served if its consultant habitually summarises the pros and cons of issues without ever taking a stand.
A good adviser knows when to express a point of view, even if the committee has not asked for an opinion.
In certain situations, the consultant may need to risk disagreeing with the committee chair. For example, directors at many companies have a tendency to rely heavily on general practice. This may be partly a function of being exposed to consultants who just refer to market practice when asked what their company should do. But in our experience, there is usually at least one instance of uniqueness in a company’s situation requiring consideration of a departure from market practice. This requires consultant intellectual ability, experience and courage to put this on the table, and committee open mindedness to consider it on its merits.
6. Will the consultant serve as a reality check?
The remuneration adviser must display a high standard of professionalism and integrity. Advisers must provide black-and-white answers if the situation demands it, with no brooking or hedging. Importantly, they must also be a voice independent of management.
But unlike much of the oversight provided by the audit committee, most decisions made by the remuneration committee are not right or wrong, but primarily matters of judgment and degree. The consultant in these situations must be able to summarise the elements that need to be considered and be prepared to say that the judgment required is a fine balance if there is no clear cut answer.
When appropriate, the consultant must also function as a brake on the decision-making process.
Committees are well served by a consultant who will take the initiative to say to members, “There are some important issues here that you’re overlooking and should be considered before you make a decision.” It is the consultant’s duty to try to persuade members to factor in new information when needed, even if doing so may end up increasing costs or result in a delay. Consultants should make sure they achieve this without being rigid or demanding. For example, if management and the committee are overly focused on how increased earnings should be reflected in pay levels, the consultant may need to point out that the organisation’s return on capital employed ranks at the bottom of its industry.
7. Will the consultant be willing to disagree with the chair? With management?
There is a fine line between being a strong advocate for a particular viewpoint and seeking to impose that opinion. But it is no better for the committee to have a consultant who will invariably support its point of view than one who automatically takes the side of management. A good remuneration consultant will tread the line but not overstep it, seeking to persuade members of what he or she believes is the right course of action in a way that is respectful of their authority.
8. Under what circumstances would the consultant sever the relationship?
Good consultants make their services and their standards clear to clients, preferably prior to engagement. The committee’s remuneration consultant should be willing to resign in situations that involve greed, dishonesty, or unethical behaviour. Not resigning jeopardises the consultant’s own credibility. As more companies disclose who their adviser is in remuneration reports (even when the committee chooses not to heed the advice), actions by the adviser to terminate the relationship may become more common than in the past.
If a consultant perceives that management and the committee have lost confidence in his or her judgment, that adviser has lost any effectiveness and should step down. Similarly, if over an extended period the consultant is unable to persuade the committee to take a course of action, or is convinced members are consistently going in the wrong direction in spite of his or her recommendations, it is probably time to end the relationship.
9. Is the committee comfortable with the consultant’s ability to appear before the full board?
With the annual media circus on executive pay, the shareholder vote on remuneration reports, and increasingly onerous disclosure requirements, remuneration committees will likely to be asked to explain and justify the recommendations they make about pay programs to the full board and to shareholders. Particularly at highly visible companies, the committee must be confident that its consultant has the experience, independence, candour, confidence, and credibility to provide technical support and advice outside the committee room.
10. Who else does the consultant work for?
The committee should insist upon full disclosure and carefully consider any conflict of interest or perception of conflict on the part of the consultant.
Such a relationship would not automatically disqualify a consultant from consideration, but should be weighed in the context of its effect on the consultant’s ability to advise them independently and on the committee’s willingness to share confidential information.
The issues include whether the consultant does other work for the company, and whether the consultant advises other companies in the same industry. The last question is particularly important when the committee will need to disclose highly confidential information regarding the company’s business plans and financial information, especially in a very competitive industry. However, the fact that the consultant advises competitors should not necessarily preclude using that adviser. Industry knowledge is essential to developing appropriate reward strategies. With Australia being such a shallow market, there is a dearth of advisers who meet the criteria in this checklist.
But these factors should not preclude the committee knowing the full extent of relationships with competitors.
11. Can the consultant participate in the shareholder proxy process?
Proxy advisory firms and institutional investors are, in Australia, a finite group of people with surprisingly different views and agendas. To what extent can your adviser assist in the process of eliciting their views, and aligning their judgment with the judgment of directors on executive remuneration matters?
In a challenging governance environment, remuneration committees increasingly will rely on their outside advisers to help them provide thorough and effective oversight of executive and director pay programs, as well as to ensure compliance. For the relationship to work, directors must be confident that consultants not only will provide the committee with accurate and meaningful data, but also will take the lead in promoting decisions in the best long-term interests of the organisation and shareholders.