Governance of Directors Remuneration

Boardroom pay has long been a contentious issue. Are there adequate safeguards to address the risk of increased focus of Directors and Executive remuneration only on their personal interests, ignoring the interests of shareholders that is affecting the viability of the company? In the Sri Lankan situation there has been no external pressure or demand for companies to set remuneration policies that safeguards the company and it’s shareholders.

Global examples of RBS and Shell
In 2009 the news of the retirement package awarded to Sir Fred Goodwin, former chief executive of Royal Bank of Scotland, met a storm of protest. The most spectacular rebellion took place at the April AGM of Royal Bank of Scotland. The company’s remuneration report was rejected by more than 90 per cent of the votes cast, with the UK Treasury adding its own 70 per cent shareholding to the cause. As Sir Fred Goodwin discovered, tolerance of ‘rewards for failure’, excessive bonuses and of any elements of remuneration that couldn’t be justified by overall company performance was not acceptable any longer.

In May 2009, blue-chip company Shell found itself in similar trouble. This time, investors focused on the use of a remuneration committee discretion that allowed pay-outs under a long-term incentive plan. Shell had narrowly failed to meet its comparative TSR target (third place for total shareholder return measured against a small group of five global oil companies), but the remuneration committee nonetheless allowed 50 per cent of awards to vest, justifying its decision on the basis of the company’s consistently strong financial performance. But the remuneration report was rejected by nearly 60 per cent of the votes cast.

Governance Initiatives
In the UK it was claimed that pay structures (particularly bonuses) had contributed to a culture of excessive risk-taking among Britain’s banks, thereby helping to precipitate a major economic crisis. This was a similar view in the US too.

The UK took the initiative to address the deteriorating situation and to improve corporate governance and reform remuneration practices, like;
1. The publication of the Financial Services Authority’s (FSA) Remuneration Code, requiring the United Kingdom’s largest financial institutions to ‘establish, implement and maintain policies, procedures and practices that are consistent with and promote effective risk management’
2. The Walker Report on the corporate governance of the financial services sector;
Some of the Walker rules on pay, include;
# The remuneration committee should be directly responsible for the pay of not just directors but also of those regarded by the FSA as having a ‘significant influence function’ or who may have ‘a material impact on the risk profile of the entity’, giving the committee a greater control over a company’s pay practices.
# The remuneration committee should have oversight of remuneration policy throughout the business, though it will only set pay packages for the most senior staff.
# The remuneration committee should confirm, in its report, that it is satisfied with the way performance objectives and risk adjustments are reflected in compensation structures for senior management.
# It must also report whether it has the power to enhance an executive’s benefits in certain circumstances such as termination of employment or a change of control.
3. A revised UK Corporate Governance Code from the Financial Reporting Council;
Some of the changes focus on aligning reward with the sustained creation of value, include;
# Greater emphasis to be placed on ensuring that remuneration policies are designed with the long-term success of the company in mind, and that the lead responsibility for doing so rests with the remuneration committee; and
# Companies should put in place arrangements that will enable them to recover or withhold variable pay when appropriate to do so, and should consider appropriate vesting and holding periods for deferred remuneration.

Conclusion
The SEC in Sri Lanka should take similar initiatives to protect shareholders and avoid misuse of office by directors. Also, take steps to strengthen the remuneration committee activities which currently is a ‘tick a box’ kind of action.

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About surenraj

“Views expressed are my own”
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