There are two key features when it comes to remuneration. First of all, a compensation package is a way to attract and retain top talent. Secondly, remuneration is a drain on the resources of any organization. In other words, resources are scarce and have to be managed carefully (Kroon, p.17). It is therefore imperative to set the remuneration levels and it must be done in accordance to sound management principles. In the case of the remuneration of an executive director, a committee must act on it based on clear directives from the company’s shareholders.
There is no need to elaborate on the importance of payment systems, according to one commentary, “it might be the main reason why people are willing to work” (Zugner & Ullrich, p.2). However, there is a need to regulate it and this assertion is based on the following principle:
Levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully, but a company should avoid paying more than is necessary for this purpose. A significant proportion of executive director’s remuneration should be structured so as to link rewards to corporate and individual performance” (Solomon, p.353).
The remuneration committee must be given the appropriate capability to set remuneration levels. This committee should have “delegated responsibility for setting remuneration for all executive directors, and the chairman, including pension right and any compensation payments” (Mantysaari, p.138). In other words, shareholders must set boundaries when it comes to remuneration levels (Mantysaari, p.138). Although many are aware of the importance of this practice, a practical and workable model is not easy to develop. However, it has to be done to protect the interest of the shareholders and to safeguard the reputation of the organization when it comes to managing its resources.
Setting Remuneration Levels
Going back to the aforementioned principle, when it comes to regulating pay, one can easily identify the tension between the need to attract and retain top talent versus the need to put a cap on remuneration levels. It is important to find the best man suited for the job and then make an offer that ensures the candidate would choose to work for that particular firm. It is common practice to offer a substantial amount because paying a high salary is much better than bankruptcy. An incompetent person sitting in the position of an executive director would cost more in the long run as opposed to paying top dollar to hire the services of a competent professional.
There is also the problem of preventing a highly-qualified executive director to seek greener pastures and transfer to a competitor. If a company experiences a high level of growth, the key players in that particular industry would try their best to convince this executive director to work for them. This is a possibility if the executive feels that the compensation given was not based on the performance and profitability of the company. In the event that the executive director leaves, the company would be in limbo, and aside from having no assurance that it can repeat its newfound success, the company also becomes less efficient as it enters a transition phase under the control of a new leader.
Some strongly oppose the idea of regulating pay. They argue that “remuneration levels are a matter for the board within the context of prudent management, of return to employees and returns to other stakeholders, taking into account performance and risk” (National Audit Office, House of Commons, p.22). This is based on the argument that a remuneration is a tool that must be used effectively. This requires the absence of limiting factors that can prevent the company from hiring the best person suited for the job.
This is a serious problem for a multi-billion company. This dilemma can best be understood in the remarks of a bank executive who said, “We argue that whilst there is a strong case for curbing or stopping bonus payments for senior staff in Lloyd’s Banking Group and Royal Bank of Scotland, we accept the argument that the position of the banks would be worsened if they could not recruit and retain talented staff” (National Audit Office, House of Commons, p.3). Corporate leaders must constantly raise the standard when it comes to remuneration levels but at the same time, they are fully aware of the implications when they are forced to pay even the executive director underperforms.
Aside from the need to show due diligence and prudence in all the business activities within a firm, the effects of the financial crisis have forced into the open a corporate practice that the general public knew very little about. The practice of giving high salaries and big bonuses is nothing new but it is only recently when investors and other stakeholders are questioning the wisdom of such practice. The counter-argument is that “Whilst such demands are understandable in the present crisis conditions, “the most prudent thing to do is to examine and penalize inappropriate remuneration practices in the banking sector solely with respect to their financial stability implications of those practices” (National Audit Office, Hose of Commons, p.22). Accountability coupled with flexibility is the best approach.
Even if there is no crisis and the company is doing well there are those who contend that remuneration levels are simply too high. The reason why there is a need to regulate pay is based on the fact that executive directors are highly-paid (Mantysaari, p.138). In most cases, the remuneration package “can consist of a base salary, performance-related pay, benefits-in-kind, and pension benefits” (Mantysaari, p.138). It is imperative to go back to the issue of demonstrating stewardship of resources and protecting the interest of investors.
An example is the case of Sir Fred Goodwin, the departing chief of the Royal Bank of Scotland who was entitled to receive hundreds of thousands of dollars per year for life as part of his pension fund (Needle, p.251). This was given to Goodwin in 2008, at the time when the bank had to be bailed out by the UK government (Needle, p.251). This evidence that only a few people have a clear understanding of how to correctly regulate remuneration levels especially when it comes to top positions in the company.
There is also the need to consider public opinion as well as the opinion of various stakeholders. For instance, in the recent financial crisis, “bank management angered the public by continuing to pay bonuses” even after they were being rescued by the government (Green, p.245). It does not create a sustainable environment where various stakeholders are willing to work hand in hand with an organization to achieve positive results.
How to Regulate Remuneration Levels
The first thing to remember is that “no director should be involved in deciding his or her own remuneration” (Hicks & Goo, p.246). Afterward, corporate leaders must establish a methodology for regulating pay. There are three different approaches when it comes to determining levels of remuneration and these are listed as follows: a) fixed levels of pay; b) reward linked to the performance of the individual; c) reward linked to the results of the company (Zugner & Ullrich, p.2). The next step is to choose someone who can deal with the specifics.
One way to accomplish this is to hire consultants. But experts studying the impact of uncontrolled remuneration levels contended that there is a “need to counterbalance the view of remuneration consultant’s advice” (Hawley, Kamath, & Williams, p.121). Apparently, the study of corporate history has revealed an undeniable fact that these consultants are not as effective as they are supposed to be (Hawley, Kamath, & Williams, p.121). There is a need to establish a remuneration committee. A remuneration committee is a way to control remuneration levels by people who are aware of the pertinent details regarding the job of an executive director (Mantysaari, p.138). A committee made up of members that are familiar with the inner workings of an organization can review the compensation package drawn up by the consultant.
It would be best to do away with the consultant and in its place, a committee handpicked and empowered by the investors. The aim is two-fold, “to avoid rewarding poor performance” and to take a “robust line on reducing compensation” (Mantysaari, p.141). But once again this is easier said than done because in most cases the members of the said committee were not given specific guidelines and appropriate tools that would help them come up with the correct remuneration package.
It is high time to point out the inherent weaknesses of “codes of corporate governance” (Hawley, Kamath, & Williams, p.121). This is based on the realization that “codes largely focus upon the structure and tasks of the remuneration committee, rather than provide guidance on the intricacies of remuneration practices” (Hawley, p.121). Consider for instance the deceptively simple definition of productivity as the “ratio of output to inputs” (Cooper, p.52). It is useful to know what has to be done but ineffective when it comes to determining how it must be done. A generalized framework cannot provide specific steps that would suit every need.
The investors must not only initiate the creation of a committee that would determine the remuneration pay of an executive director, but they must also draw up specific guidelines that would enable them to develop a remuneration package that is “sufficient to attract, retain and motivate directors of the quality needed to run the company successfully” but at the same time avoiding paying more than is necessary” (Morris, McKay, & Oates, p.286). The following are some of the practical steps that the committee can use as part of its guidelines.
The procedure should be clear: “There should be a formal and transparent procedure for developing a policy on executive remuneration and for fixing the remuneration packages of individual directors” (Morris, McKay, & Oates, p.286). At the same time, “They should be sensitive to pay and employment condition elsewhere in the group (Dunne & Morris, p.192). It is also imperative that committee members are able to “judge where to position their company relative to other companies” (Solomon, p.353). This is done to structure remuneration levels that “encourages a better balance between the short and the long term” (Hawley, Kamath, & Williams, p.23). An example is a use of “clawback mechanism” wherein “previously given monies or benefits that are taken back as a consequence of particular circumstances” (National Audit Office, House of Commons, p23). For instance, a “clawback mechanism” takes back “bonuses when the company is involved in a transaction that subsequently turned out to involve significant loss or some form of deferral” (National Audit Office, House of Commons, p.23). This is a fair deal from the perspective of investors and various stakeholders.
There is a clear dilemma when it comes to regulating remuneration levels. There is a practical reason why a cap should be set for high salaries and big bonuses. This is especially true when an executive director underperforms. On the other hand, there is the fear that it stifles the ability to hire the best person for the job. The solution to this problem lies in the hands of investors. They must take the initiative in creating a committee that has been given specific guidelines on how to draw up a compensation package that can attract and retain top talent.
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