9 Directors’ Performance

and Remuneration
Learning Objectives
● To be aware of the main features of the directors’ remuneration debate
● To know the key elements of directors’ remuneration
● To assess the role of the remuneration committee in setting directors’
remuneration
● To understand the different measures used to link directors’ remuneration with
performance
● To know the disclosure requirements for directors’ remuneration
● To be aware of possible ways of evaluating directors

The directors’ remuneration debate

The last decade has seen considerable shareholder, media, and policy attention given to the
issue of directors’ remuneration. The debate has tended to focus on four areas: (i) the overall
level of directors’ remuneration and the role of share options; (ii) the suitability of performance
measures linking directors’ remuneration with performance; (iii) the role played by the
remuneration committee in the setting of directors’ remuneration; (iv) the influence that
shareholders are able to exercise on directors’ remuneration.
The debate about directors’ remuneration spans continents and is a topic that is as hotly
debated in the USA as it is in the UK. Indeed, the UK’s use of share options as long-term
incentive devices has been heavily influenced by US practice. Countries that are developing
their corporate governance codes are aware of the ongoing issues relating to directors’
remuneration and try to address these issues in their own codes. In the UK the debate was
driven in the early years by the remuneration packages of the directors of the newly priva-
tized utilities. The perception that directors were receiving huge remuneration packages—
and often, it seemed, with little reward to the shareholders in terms of company
performance—further fuelled the interest in this area on both sides of the Atlantic. The level
of directors’ remuneration continues to be a worrying trend and as Lee (2002) commented
‘the evidence in the US is of many companies having given away 10 per cent, and in some
cases as much as 30 per cent, of their equity to executive directors and other staff in just the
last five years or so. That is clearly not sustainable into the future: there wouldn’t be any
companies left in public hands if it were’.
It is interesting to note that a comparison of remuneration pay and incentives of directors
in the USA and the UK gives a useful insight. Conyon and Murphy (2000) documented the
198 DIRECTORS AND BOARD STRUCTURE

differences in chief executive officer (CEO) pay and incentives in both countries for 1997.
They found that CEOs in the USA earned 45 per cent higher cash compensation and 190 per
cent higher total compensation than their counterparts in the UK. The implication is that, in
the USA, the median CEO received 1.48 per cent of any increase in shareholder wealth com-
pared to 0.25 per cent in the UK. The difference being largely attributable to the extent of the
share option schemes in the USA.
The directors’ remuneration debate clearly highlights one important aspect of the
principal–agent problem discussed at length in Chapter 2. In this context, Conyon and Mal-
lin (1997) highlight that shareholders are viewed as the ‘principal’ and managers as their
‘agents’, and that the economics literature, in particular, demonstrates that the compensa-
tion received by senior management should be linked to company performance for incen-
tive reasons. Well-designed compensation contracts will help to ensure that the objectives
of directors and shareholders are aligned, and so share options and other long-term incen-
tives are a key mechanism by which shareholders try to ensure congruence between
directors’ and shareholders’ objectives.
However, Bebchuk and Fried (2004) highlight that there are significant flaws in pay
arrangements, which ‘have hurt shareholders both by increasing pay levels and, even more
important, by leading to practices that dilute and distort managers’ incentives’. More recently
the global financial crisis has served to highlight the inequities that exist between executive
directors’ generous remuneration and the underperformance of the companies that they
direct, and the concomitant impact on shareholders who may lose vast sums of money,
sometimes their life savings, and employees who may find themselves on shorter working
weeks, lower incomes, or being made redundant. The International Labour Organization
(ILO) 2008 reported that,

the gap in income inequality is also widening—at an increasing pace—between top executives
and the average employee. For example, in the United States in 2007, the chief executive
officers (CEOs) of the 15 largest companies earned 520 times more than the average worker.
This is up from 360 times more in 2003. Similar patterns, though from lower levels of
executive pay, have been registered in Australia, Germany, Hong Kong (China), the
Netherlands and South Africa.

Furthermore the ILO state that,

developments in global corporate governance have also contributed to perceptions of

excessive income inequality. A key development has been the use of so-called ‘performance
pay systems’ for chief executive managers and directors . . . Importantly, empirical studies
show only very moderate, if any, effects of these systems on company performance.
Moreover, large country variations exist, with some countries displaying virtually no relation
between performance-pay and company profits.  .  . . Altogether, evidence suggests that
developments in executive pay may have been both inequality-enhancing and economically
inefficient.

In the context of the global banking crisis, the UK’s Turner Review reported in March 2009,
and highlighted that executive compensation incentives encouraged ‘some executives and
traders to take excessive risks’. The Review emphasizes the distinction between ‘short-term
remuneration for banks which have received taxpayer support which is a legitimate issue of
public concern, and one where governments as significant shareholders have crucial roles to
 DIRECTORS’ PERFORMANCE AND REMUNERATION 199

play’ and ‘long-term concerns about the way in which the structure of remuneration can
create incentives for inappropriate risk taking’. The Review therefore recommends that risk
management considerations are embedded in remuneration policy, which of course has
implications for the remit of remuneration committees and for the amount of time that non-
executive directors may need to give.
The House of Commons Treasury Committee reporting in May 2009 on the Banking Crisis:
Reforming Corporate Governance and Pay in the City stated:
Whilst the causes of the present financial crisis are numerous and diverse, it is clear that
bonus-driven remuneration structures prevalent in the City of London as well as in other
financial centres, especially in investment banking, led to reckless and excessive risk-taking.
In too many cases the design of bonus schemes in the banking sector were flawed and not
aligned with the interests of shareholders and the long-term sustainability of the banks.

The Committee also refers to the complacency of the Financial Services Authority (FSA) and
states ‘The Turner Review downplays the role that remuneration structures played in causing
the banking crisis, and does not appear to us to accord a sufficiently high priority to a
fundamental reform of the bonus culture’. The Committee urges the FSA not to shy away
from using its powers to sanction firms whose activities fall short of good practice. The
Committee also encourages the use of deferral or clawback mechanisms to help ensure that
bonus payments align the interests of senior staff more closely with those of shareholders.
Moreover, the Committee believes that links should be strengthened between the
remuneration, risk, and audit committees, ‘given the cross-cutting nature of many issues,
including remuneration’ and also advocates
that remuneration committees would also benefit from having a wider range of inputs from
interested stakeholders—such as employees or their representatives and shareholders. This
would open up the decision-making process at an early stage to scrutiny from outside the
board, as well as provide greater transparency. It would, additionally, reduce the dependence
of committees on remuneration consultants.

Sir David Walker headed a review of corporate governance in the banking sector which reported
in 2009. Of its thirty-nine recommendations, twelve related to remuneration (including the role
of the board remuneration committee, disclosure of executive remuneration, and the Code of
Conduct for executive remuneration consultants written by the Remuneration Consultants
Group). Some of the recommendations were to be taken forward by the FRC through
amendments to the Combined Code, whilst others were to be taken forward by the FSA. When
the UK Corporate Governance Code 2010 (’the Code’) was introduced, it incorporated some of
the Walker Report recommendations, including that performance-related pay should be
aligned to the long-term interests of the company and to its risk policy and systems.
The Department for Business, Innovation & Skills (BIS) issued a discussion paper on exec-
utive remuneration in September 2011. The paper highlights the increasing disparity between
the pay of CEOs and employees in the largest companies, and cites evidence to suggest that
executive pay, particularly at CEO level in FTSE 100 companies, bears very little relationship
to company performance or shareholder returns.
The High Pay Commission is an independent inquiry into high pay and boardroom pay
across the public and private sectors in the UK. In 2010 they started their year-long
inquiry into pay at the top of UK companies and found ‘evidence that excessive high pay
200 DIRECTORS AND BOARD STRUCTURE

damages companies, is bad for our economy and has negative impacts on society as a
whole. At its worst, excessive high pay bears little relation to company success and is re-
warding failure.’ Their report More for Less: what has happened to pay at the top and does
it matter? issued in May 2011, stated: ‘Pay is about just rewards, social cohesion and a
functioning labour market, and it is the view of the High Pay Commission that the expo-
nential pay increases at the top of the labour market are ultimately a form of market
failure’. The report identifies four causes of the dramatic growth in top pay: attempts
to link pay to performance, company structures fail to exert proper control over top
earnings, the labour market contributes to increasing pay at the top, and the rise in
individualism.
Their report What are we paying for? Exploring executive pay and performance (2011) finds
that, in addition to an average rise in FTSE 350 salaries of 63.9 per cent between 2002 and
2010, average bonuses increased from 48 per cent to 90 per cent of salary in the same period.
Comparing company performance to stock and balance sheet performance, the report sug-
gests that ‘salary growth bears no relation to either market capitalisation, earnings per share
(EPS) or pre-tax profit’ and that ‘there is no or little relation between the total earnings trends
and market capitalisation’.
The High Pay Commission’s final report Cheques with Balances: why tackling high pay is in
the national interest was issued in November 2011. The report recommends a twelve-point
plan based on the principles of accountability, transparency, and fairness aimed at redressing
the out-of-control executive pay spiral. The report highlights some of the excesses, for
example: ‘In BP, in 2011 the lead executive earned 63 times the amount of the average
employee. In 1979 the multiple was 16.5. In Barclays, top pay is now 75 times that of the
average worker. In 1979 it was 14.5. Over that period, the lead executive’s pay in Barclays has
risen by 4,899.4%—from £87,323 to a staggering £4,365,636’.
The High Pay Commission’s twelve recommendations, under three headings, are as
follows:

Transparency

1. Pay basic salaries to company executives (remuneration committees may elect to award
one additional performance-related element only where it is absolutely necessary).
2. Publish the top ten executive pay packages outside the boardroom.
3. Standardise remuneration reports.
4. Require fund managers and investors to disclose how they vote on remuneration.

Accountability

5. Include employee representation on remuneration committees.

6. All publicly listed companies should publish a distribution statement (to show the
distribution of income over a period of three years, importantly showing percentage
changes in: total staff costs; company reinvestment; shareholder dividends; executive
team total package; and tax paid.
 DIRECTORS’ PERFORMANCE AND REMUNERATION 201

7. Shareholders should cast forward-looking advisory votes on remuneration reports

(votes should be cast on remuneration arrangements for three years following the
date of the vote and these arrangements should include future salary increases, bonus
packages and all hidden benefits, giving shareholders a genuine say in the
remuneration of executives).
8. Improve investment in the talent pipeline.
9. Advertise non-executive positions publicly—(helping to make remuneration
committees open to a wider group, encouraging diversity and ending the closed shop
culture of appointments.
10. Reduce conflicts of interest of remuneration consultants.

Fairness

11. All publicly listed companies should produce fair pay reports.
12. Establish a permanent body to monitor high pay (on a social partnership basis, much
like the Low Pay Commission by government to: monitor pay trends at the top of the
income distribution; police pay codes in UK companies; ensure company legislation is
effective in ensuring transparency, accountability and fairness in pay at the top of
British companies; and report annually to government and the public on high pay.

Vince Cable, the Business Secretary, has taken forward ten of the twelve recommendations
from the High Pay Commission. Furthermore, in January 2012 he announced the govern-
ment’s next steps to address failings in the corporate governance framework for executive
remuneration. These included:
● greater transparency in directors’ remuneration reports;
● empowering shareholders and promoting shareholder engagement through enhanced
voting rights;
● increasing the diversity of boards and remuneration committees;
● encouraging employees to be more engaged by exercising their right to Information and
Consultation Arrangements;
● working with investors and business to promote best practice on pay-setting.
Following this, a consultation on Executive Pay and Enhanced Shareholder Rights was
launched, which provides more details on a new model for shareholder voting. The BIS
website lists the main components of this as:
● an annual binding vote on future remuneration policy;
● increasing the level of support required on votes on future remuneration policy;
● an annual advisory vote on how remuneration policy has been implemented in the
previous year;
● a binding vote on exit payments over one year’s salary.
The outcome of the consultation, which closed in April 2012, is awaited.
202 DIRECTORS AND BOARD STRUCTURE

As part of government reforms in this area, Deborah Hargreaves, who chaired the High
Pay Commission, will run a new High Pay Centre to monitor pay at the top of the income
distribution and set out a road map towards better business and economic success. In May
2012 the High Pay Centre issued It’s How You Pay It, a report that looked at the current situ-
ation with regard to executive pay packages, the elements included in them, and how they
can be calculated. The report states that: ‘Levels of pay matter, and how we pay people mat-
ters too. While the corporate world has embraced wholeheartedly the idea that you can
incentivise those at the top to act in the interests of shareholders, at best we can argue that
evidence is unclear. At worst it is fair to say that the case against large variable awards is
increasingly compelling’. The report also points out that ‘providing a single figure for the pay
awarded in any one year is an essential step forward for businesses’ although it recognizes
that this may, in itself, be a complex exercise.
As can be seen, there has been much heated debate about flawed remuneration packages
which enable large bonuses to be paid even when the company has not met the perfor-
mance criteria associated with those bonuses; which also allow departing directors to have
golden goodbyes in the form of generous (some would say obscene) payments into their
pension pots, or other means of easing their departure from the company; and bring about
much distaste regarding the growing multipliers of executive remuneration compared to
that of the average employee. The debate is far from over, although one thing is certain,
which is that the remuneration committees and the shareholders will be looking ever more
carefully at the remuneration packages being proposed for executive directors in the future,
given the expectations of government and the public about what remuneration packages
should look like.
Finally, the issuance in December 2010 by the FSA of ‘PS10/20 Revising the Remuneration
Code’ should be mentioned. The revised framework for regulating financial services firms’
remuneration structures and extension of the scope of the FSA Remuneration Code, arose
primarily as a result of amendments to the Capital Requirements Directive (CRD3) which
aimed to align remuneration principles across the EU, but also took into account provisions
relating to remuneration within the Financial Services Act 2010, Sir David Walker’s review of
corporate governance, and also lessons learned from the FSA’s implementation of its Remu-
neration Code. The FSA states: ‘Our Remuneration Code sets out the standards that banks,
building societies and some investment firms have to meet when setting pay and bonus
awards for their staff. It aims to ensure that firms’ remuneration practices are consistent with
effective risk management’. The twelve Principles cover the three main areas of regulatory
scope: governance; performance measurement; and remuneration structures. The headings
encompass:

● risk management and risk tolerance;

● supporting business strategy, objectives, values and long-term interests of the firm;
● avoiding conflicts of interest;
● governance;
● control functions;
● remuneration and capital;
● exceptional government intervention;
 DIRECTORS’ PERFORMANCE AND REMUNERATION 203

● profit-based measurement and risk adjustment;

● pension policy;
● personal investment strategies;
● avoidance of the FSA Remuneration Code;
● remuneration structures;
● the effect of breach of the FSA Remuneration Principles.
It also introduced some new rules, for example on discretionary severance pay, linking
remuneration to a firm’s capital base, and discretionary pension payments.

Key elements of directors’ remuneration

Directors’ remuneration can encompass six elements:
● base salary;
● bonus;
● stock options;
● restricted share plans (stock grants);
● pension;
● benefits (car, healthcare, etc.).
However, most discussions of directors’ remuneration will tend to concentrate on the first
four elements listed earlier and this text will also take that approach.

Base salary
Base salary is received by a director in accordance with the terms of his/her contract. This
element is not related either to the performance of the company nor to the performance of
the individual director. The amount will be set with due regard to the size of the company,
the industry sector, the experience of the individual director, and the level of base salary in
similar companies.

Bonus
An annual bonus may be paid, which is linked to the accounting performance of the firm.

Stock options
Stock options give directors the right to purchase shares (stock) at a specified exercise price
over a specified time period. Directors may also participate in long-term incentive plans
(LTIPs). UK share options generally have performance criteria attached, and much discussion
is centred around these performance criteria, especially as to whether they are appropriate
and demanding enough.
204 DIRECTORS AND BOARD STRUCTURE

Restricted share plans (stock grants)

Shares may be awarded with limits on their transferability for a set time (usually a few years),
and various performance conditions should be met.

Role of the remuneration committee

The Code (2010) recommends that ‘there should be a formal and transparent procedure for
developing policy on executive remuneration and for fixing the remuneration packages of
individual directors’ (principle D.2). In practice, this normally results in the appointment of a
remuneration committee.
The remuneration committee’s role and composition was discussed in Chapter 8.
However, in this chapter we consider the effect of remuneration committees on direc-
tors’ remuneration levels in recent years. Sykes (2002) points out that, although remu-
neration committees predominantly consist of a majority, or more usually entirely, of
non-executive directors, these non-executive directors ‘are effectively chosen by, or only
with the full agreement of, senior management’. Given that the non-executive directors
of one company may be executive directors of another (unrelated) company, they may
not be willing to stipulate demanding performance criteria because they may have a
self-interest in ensuring that they themselves can go on earning a high salary without
unduly demanding performance criteria being set by their own companies’ remunera-
tion committees. There is also another aspect, which is that remuneration committees
will generally not wish the executive directors to be earning less than their counterparts
in other companies, so they will be more inclined to make recommendations that will
put the directors into the top or second quartile of executive remuneration levels. It is
certainly the case that executive remuneration levels have increased fairly substantially
since remuneration committees were introduced which, of course, was not the intended
effect. Sykes (2002) makes the pertinent point that all the remuneration packages now so
widely criticized as flawed and inappropriate were once approved by an ‘independent’
remuneration committee.
The performance measures that the remuneration committee decides should be used are
therefore central to aligning directors’ performance and remuneration in the most appro-
priate way. Remuneration committees are offered some general guidance by the Code (2010)
recommendation that ‘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’ (principle D.1).
In the UK both the National Association of Pension Funds (NAPF) and the Association of
British Insurers (ABI) have been involved in the debate about executive remuneration and
have issued guidance in this area. The ABI (2002) Guidelines on Executive Remuneration
included the recommendations that:
● remuneration packages should have a balance between fixed and variable pay,
and between long- and short-term incentives;
● performance-based remuneration arrangements should be demonstrably clearly
aligned with business strategy and objectives;
 DIRECTORS’ PERFORMANCE AND REMUNERATION 205

● the remuneration committee should have regard to pay and conditions generally in the
company, taking into account business size, complexity, and geographical location and
should also consider market forces generally;
● share option schemes should link remuneration to performance and align the long-term
interests of management with those of shareholders;
● performance targets should be disclosed in the remuneration report within the bounds
of commercial confidentiality considerations.
In December 2005 the ABI issued its Principles and Guidelines on Remuneration, which have
a two-fold aim of providing ‘a practical framework and reference point for both shareholders
in reaching voting decisions and for companies in deciding upon remuneration policy’. The
Principles and Guidelines emphasize that remuneration (committee) reports should provide
a clear and full explanation of remuneration policy, showing a clear link between reward
and performance and that ‘shareholders believe that the key determinant for assessing
remuneration is performance in the creation of shareholder value’.
In December 2007 the ABI made some minor amendments to its Executive Remuneration—
ABI Guidelines on Policies and Practices. In September 2008 the ABI wrote a letter to the chairmen
of the remuneration committees explaining that it did not plan to make any changes at that
time to the ABI (2007) guidelines. However, the letter highlighted a number of areas to which
the ABI wished to draw attention in the current economic climate. The points raised were:
(i) the remuneration policy should be fully explained and justified, particularly when changes
are proposed. Members will carefully scrutinise remuneration uplifts, particularly increases
in salaries or annual bonus levels; (ii) where a company has underperformed and seen a
significant fall in its share price, this should be taken into account when determining the level
of awards under share incentive schemes. In such circumstances, it is not appropriate for
executives to receive awards of such a size that they are perceived as rewards for failure;
(iii) shareholders are generally not in favour of additional remuneration being paid in relation
to succession or retention, particularly where no performance conditions are attached;
(iv) in the context of the consultation process for share incentive schemes, Remuneration
Committees should ensure that shareholders have adequate time to consider the proposal
and that their views are carefully considered. Relevant information related to the consultation
should be clearly and fully disclosed.

In September 2011 the ABI issued the ABI Principles of Executive Remuneration, which are
predominantly for companies with a main market listing but useful for companies on other
public markets and also for other entities. The Principles relate to (in a remuneration
context), the role of shareholders, the role of the board and directors, the remuneration
committee, remuneration policies, and remuneration structures. There is detailed guidance
for remuneration committees.

Role of remuneration consultants

Remuneration committees may draw on the advice of specialist remuneration consultants
when constructing executive remuneration packages. The role of remuneration (compensation)
consultants has started to receive more attention in the last few years in the academic
206 DIRECTORS AND BOARD STRUCTURE

literature. Voulgaris et al. (2010) in a study of 500 UK firms from the FTSE 100, FTSE 250, and
the Small Cap indices, find that compensation consultants may have a positive effect on the
structure of CEO pay since they encourage incentive-based compensation, and they also
show that economic determinants, rather than CEO power, explain the decision to hire
compensation consultants.
Murphy and Sandino (2010) examine the potential conflicts of interest that remuneration
consultants face, which may lead to higher recommended levels of CEO pay. They find ‘evi-
dence in both the US and Canada that CEO pay is higher in companies where the consultant
provides other services, and that pay is higher in Canadian firms when the fees paid to con-
sultants for other services are large relative to the fees for executive-compensation services.
Contrary to expectations, we find that pay is higher in US firms where the consultant works
for the board rather than for management.
Similarly, Conyon et al. (2011), in a study of compensation consultants used in 232 large
UK companies, find that ‘consultant use is associated with firm size and the equity pay mix.
We also show that CEO pay is positively associated with peer firms that share consultants,
with higher board and consultant interlocks, and some evidence that where firms supply
other business services to the firm, CEO pay is greater’.
Bender (2011), drawing on interview data with a selection of FTSE 350 companies, finds
remuneration committees employ consultants for a number of reasons. First,
the consultant is to act as an expert, providing proprietary data against which companies can
benchmark pay, and giving insight and advice into the possibilities open for plan design and
implementation. In this role, consultants have a direct and immediate influence on executive
pay. That is, by influencing the choice of comparators, consultants both identify and drive
the market for executive pay. They also bring to bear their knowledge of pay plans, and their
views on what is currently acceptable to the market, thus spreading current practice more
widely and institutionalizing it aṣbest practice.

Secondly, they act as liaisons and serve an important role in the communication with
certain institutional investors. Thirdly Bender finds that they legitimize the decisions of the
remuneration committee by providing an element of perceived independence but she
points out that ‘this route to legitimacy is under threat as various constituencies question
consultants‘ independence’.
Also questioning the independence of remuneration consultants, Kostiander and Ikäheimo
(2012), examine the remuneration consultant–client relationship in the non-Anglo-American
context of Finland, focusing on what consultants do under heavy political remuneration
guidance. Their findings show that ‘restrictive remuneration guidelines can be ineffective and
lead to standardized pay designs without providing competitive advantage. Shareholders
should request greater transparency concerning remuneration design. The role of consul-
tants should be considered proactively in the guidelines, even by limiting the length of the
consultant–client relationship or increasing their transparency’.
There does therefore seem to be a growing body of evidence highlighting the role of
remuneration consultants in the setting of executive remuneration, and raising issues re-
lating to their independence and the impact on CEO pay when the remuneration consultants
offer other services to the firm.
 DIRECTORS’ PERFORMANCE AND REMUNERATION 207

Performance measures
Performance criteria will clearly be a key aspect of ensuring that directors’ remuneration is
perceived as fair and appropriate for the job and in keeping with the results achieved by the
directors. Performance criteria may differentiate between three broadly conceived types of
measures: (i) market-based measures; (ii) accounts based measures; and (iii) individual based
measures. Some potential performance criteria are:
● shareholder return;
● share price (and other market based measures);
● profit-based measures;
● return on capital employed;
● earnings per share;
● individual director performance (in contrast to corporate performance measures).
Sykes (2002) highlights a number of problems with the way in which executive remuneration
is determined: (i) management is expected to perform over a short period of time and this is
a clear mismatch with the underlying investor time horizons; (ii) management remuneration
is not correlated to corporate performance; (iii) earnings before interest, tax, and amortisation
(EBITA) is widely used as a measure of earnings and yet this can encourage companies to gear
up (or have high leverage) because the measure will reflect the flow of earnings from high
leverage but not the service (interest) charge for that debt. He suggests that the situation
would be improved if there were: longer term tenures for corporate management; more
truly independent non-executive directors; the cessation of stock options and, in their place,
a generous basic salary and five-year restricted shares (shares that could not be cashed for
five years).
The ABI (2002, 2005) guidelines state that total shareholder return relative to an appro-
priate index or peer group is a generally acceptable performance criterion. The guidelines
also favour performance being measured over a period of at least three years to try to ensure
sustained improvements in financial performance rather than the emphasis being placed on
short-term performance. Share incentive schemes should be available to employees and
executive directors but not to non-executive directors (although non-executive directors are
encouraged to have shareholdings in the company, possibly by receiving shares in the com-
pany, at full market price, as payment of their non-executive director fees).
The ABI published its Disclosure Guidelines on Socially Responsible Investment in 2007.
Interestingly, the guidelines said that the company should state in its remuneration report
‘whether the remuneration committee is able to consider corporate performance on ESG
[environmental, social, and governance] issues when setting remuneration of executive
directors. If the report states that the committee has no such discretion, then a reason should
be provided for its absence’. Also ‘whether the remuneration committee has ensured that the
incentive structure for senior management does not raise ESG risks by inadvertently moti-
vating irresponsible behaviour’. These are significant recommendations in the bid to have
ESG issues recognized and more widely taken into consideration.
208 DIRECTORS AND BOARD STRUCTURE

Another area that has attracted attention, and which is addressed in joint ABI/NAPF guid-
ance, is the area of ‘golden goodbyes’. This is another dimension to the directors’ remunera-
tion debate because it is not only ongoing remuneration packages that have attracted
adverse comment, but also the often seemingly excessive amounts paid to directors who
leave a company after failing to meet their targets. Large pay-offs or ‘rewards for failure’ are
seen as inappropriate because such failure may reduce the value of the business and threaten
the jobs of employees. Often the departure of underperforming directors triggers a clause in
their contract that leads to a large undeserved pay-off, but now some companies are cutting
the notice period from one year to, for example, six months where directors fail to meet
performance targets over a period of time, so that a non-performing director whose contract
is terminated receives six months’ salary rather than one year’s salary.
The ABI/NAPF guidance emphasizes the importance of ensuring that the design of con-
tracts should not commit companies to payment for failure; the guidance also suggests that
phased payments are a useful innovation to include in directors’ contracts. A phased pay-
ment involves continuing payment to a departing director for the remaining term of the
contract but payments cease when the director finds fresh employment. An alternative sug-
gested by the Myners Report (2001) is that compensation for loss of office should be fixed as
a number of shares in the company (and hence the value of the compensation would be
linked to the share price performance of the company).
It does seem that the days of lucrative payments for underperforming directors are
drawing to a close. Furthermore, the UK’s Department of Trade and Industry (DTI) issued a
consultation document in summer 2003, ‘Rewards for Failure: Directors’ Remuneration—
Contracts, Performance and Severance’, which invites comment on ways in which severance
pay might be limited by restricting notice periods to less than one year, capping the level of
liquidated damages, using phased payments, and limiting severance pay where a company
has performed poorly.
In February 2008 the ABI and the NAPF issued joint guidance entitled Best Practice on
Executive Contracts and Severance—A Joint Statement by the Association of British Insurers and
the National Association of Pension Funds. The guidance aims to assist boards and their remu-
neration committees ‘with the design and application of contractual obligations for senior
executives so that they are appropriately rewarded but are not rewarded for under-performance’.
The concluding statement to the guidance succinctly sums up the views of many: ‘It is unac-
ceptable that poor performance by senior executives, which detracts from the value of an
enterprise and threatens the livelihood of employees, can result in excessive payments to
departing directors. Boards have a responsibility to ensure that this does not occur’.
In relation to bonuses, Fattorusso et al. (2007) point out that
the focus of most criticism has been on salary, severance payments and various long-term
incentives (particularly share options). However, executive bonuses have attracted little
attention and have been only lightly regulated. This raises important questions. Has lighter
regulation been associated with significant levels of rent extraction through bonuses, that is,
a weak relation between bonus pay and shareholder returns?

In March 2012 Hermes Equity Ownership Services (Hermes EOS) and the NAPF, for the first
time brought together remuneration committee members from forty-four of the FTSE 100
companies and forty-two occupational pension funds from across the globe. The dialogue
 DIRECTORS’ PERFORMANCE AND REMUNERATION 209

focused on executive pay structures and how long-term investors can best challenge, and
support companies in improving remuneration practices through engagement and the
considered use of their voting powers. The intention is to shift the current political and
societal debate with the view of creating greater alignment between companies and their
shareholders, and to promote a culture within companies that rewards long-term success
and alignment across the organization.

Remuneration of non-executive directors

The remuneration of non-executive directors is decided by the board, or where required by
the articles of association, or the shareholders in general meeting. Non-executive directors
should be paid a fee commensurate with the size of the company, and the amount of time
that they are expected to devote to their role. Large UK companies would tend to pay in
excess of £50,000 (often considerably more) to each non-executive director. The remuneration
is generally paid in cash although some advocate remunerating non-executive directors with
the company’s shares to align their interests with those of the shareholders. However, it has
generally been viewed as not being a good idea to remunerate non-executive directors with
share options (as opposed to shares) because this may give them a rather unhealthy focus on
the short-term share price of the company.
Nonetheless, in 2010 the International Corporate Governance Network (ICGN) published
its Non-executive Director Remuneration Guidelines and Policies. The recommendations
include that the retainer/annual fee should be the only form of cash compensation paid to
non-executive directors, and that there should not be a separate fee for attendance at board
meetings or at committee meetings. However, it is recognized that companies may want to
differentiate the fee amount to reflect the differing workloads of individual non-executive
directors, for example, where a non-executive director is also a committee chair. Interest-
ingly, the guidelines state that, in order to align non-executive director–shareowner interests,
non-executive directors may receive stock awards or similar. However, any such ‘equity-
based compensation to non-executive directors should be fully vested on the grant date . . .
a marked difference to the ICGN’s policy on executive compensation which calls for
performance-based vesting on equity-based awards’.
Importantly, the ICGN also states: ‘Separate from ownership requirements, the ICGN
believes companies should adopt holding requirements for a significant majority of equity-
based grants. These policies should require that non-executive directors retain a significant
portion of equity grants until at least two years after they are retired from the board’. Such
policies would help ensure that interests remain aligned.
There has been relatively little academic research into non-executive directors’ remuner-
ation. Hahn and Lasfer (2011) referred to non-executive directors’ remuneration as ‘an
enigma’. A recent study by Gaia et al. (2012) compares the remuneration of independent
non-executive directors in Italy and the UK. The authors find that ‘independent non-executive
directors do not receive performance-based remuneration except in very limited instances.
In line with equity and human capital theories, we find that independent non-executive
directors do receive higher remuneration when they exert more effort, have more responsi-
bilities, and have a higher human capital’.
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Disclosure of directors’ remuneration

There has been much discussion about how much disclosure there should be of directors’
remuneration and how useful detailed disclosures might be. The Greenbury Report, issued
in the UK in 1995, was established on the initiative of the Confederation of British Industry
(CBI) because of public concern about directors’ remuneration. Whilst the work of the
Greenbury Report focused on the directors of public limited companies, it hoped that both
smaller listed companies and unlisted companies would find its recommendations useful.
Central to the Greenbury Report recommendations were the strengthening of account-
ability and enhancing the performance of directors. These two aims were to be achieved by
(i) the establishment of remuneration committees comprised of independent non-executive
directors who would report fully to the shareholders each year about the company’s execu-
tive remuneration policy, including full disclosure of the elements in the remuneration of
individual directors; and (ii) the adoption of performance measures linking rewards to the
performance of both the company and individual directors, so that the interests of directors
and shareholders were more closely aligned.
One of the Turnbull Committee recommendations (1999, revised 2005) was that boards
should consider whether business objectives and the risk management/control systems
of a business are supported by the performance-related reward system in operation in a
company.
As part of the accountability/transparency process, the remuneration committee mem-
bership should be disclosed in the company’s annual report, and the chairman of the remu-
neration committee should attend the company’s annual general meeting to answer any
questions that shareholders may have about the directors’ remuneration.
The DTI published its Directors’ Remuneration Report Regulations 2002. These regulations
require, inter alia, that:
● quoted companies must publish a detailed report on directors’ pay as part of their
annual reporting cycle, and this report must be approved by the board of directors;
● a graph of the company’s total shareholder returns over five years, against a comparator
group, must be published in the remuneration committee report;
● names of any consultants to the remuneration committee must be disclosed, including
whether they were appointed independently, along with the cost of any other services
provided to the company;
● companies must hold a shareholder vote on the directors’ remuneration report at each
general meeting.
The stipulation that companies must hold a shareholder vote on the directors’ remuneration
report is an interesting one, and something that various shareholder representative groups
have campaigned for over a long period of time. However, the vote is an advisory shareholder
vote, but it will serve a useful purpose of ensuring that the shareholders can vote specifically
on directors’ remuneration, which has caused so much heated debate for so long. The other
provisions will help to strengthen the role of the remuneration committee and enhance both
the accountability and transparency of the directors’ remuneration-setting process. The
disclosures relating to the consultants used by the remuneration committee may also lead to
 DIRECTORS’ PERFORMANCE AND REMUNERATION 211

interesting questions relating to any other services they may provide to a company to try to
determine their independence.
The ILO (2008) reports:
Disclosure practices differ widely across countries. While some countries, including France,
the Netherlands, the United Kingdom and the United States require companies to report
detailed compensation data in a remuneration report, others like Greece, have no specific
requirements .  .  . companies in such countries as Brazil, Germany, Japan and Mexico
frequently report only aggregate data on executive compensation .  .  . In some countries,
executives seem to consider the disclosure of the precise amount of remuneration to be a
risk to their personal safety. (Leal and Carvalhal da Silva, 2005)

International guidance on executive remuneration

International Corporate Governance Network (ICGN)
The ICGN issued its recommendations on best practice for executive remuneration in 2003.
It was hoped that the recommendations would create a consensus amongst both companies
and investors around the world about the structure of remuneration packages.
The ICGN recommendations stated that the ‘fundamental requirement for executive
remuneration reporting is transparency’. This was the starting point: that there should be
disclosure of the base salary, short-term and long-term incentives, and any other payments
or benefits to each main board director. The remuneration committee should publish state-
ments on the expected outcomes of the remuneration structures, in terms of ratios between
base salaries, short-term bonuses, and long-term rewards, making both ‘high’ and ‘low’
assumptions as well as the ‘central’ case. Whilst recognizing that share options are probably
here to stay, the ICGN recommendations supported the International Accounting Standards
Board (IASB) proposal to expense share options through the profit and loss account.
The remuneration committee report should be presented as a separate voting item at
every annual meeting (this would depend on local practice). The ICGN also urged institu-
tional investors to devote more resources to the analysis of remuneration resolutions.
In 2004 the ICGN published statements about the compliance of each of the UK, USA, and
Australia with the ICGN’s Executive Remuneration Principles. Each of these countries generally
complied with the principles, although each had strengths and weaknesses on particular issues.
In 2006 the ICGN approved the updated ICGN Remuneration Guidelines. Three principles
underpin the new guidelines: transparency, accountability, and the performance basis. The
guidelines state that there should also be thought given to the reputational aspects of
remuneration.
At present the ICGN have circulated recommendations on non-executive director remu-
neration (discussed earlier) but no further guidelines on executive remuneration.

Organisation for Economic Co-operation and Development (OECD)

The OECD Corporate Governance Committee (2010) in Corporate Governance and the
Financial Crisis: Conclusions and Emerging Good Practices to Enhance Implementation of the
Principles (hereafter ‘the Conclusions’) noted that
212 DIRECTORS AND BOARD STRUCTURE

the ability of the board to effectively oversee executive remuneration appears to be a key
challenge in practice and remains one of the central elements of the corporate governance
debate in a number of jurisdictions. The nature of that challenge goes beyond looking
merely at the quantum of executive and director remuneration (which is often the focus of
the public and political debate), and instead more toward how remuneration and incentive
arrangements are aligned with the longer term interests of the company.

Furthermore, they highlight that policymakers have ‘focused more on measures that seek to
improve the capacity of firm governance structures to produce appropriate remuneration
and incentive outcomes. These can roughly be characterized in terms of internal firm
governance (and, in particular, fostering arms-length negotiation through mandating certain
levels of independence), and providing a mechanism to allow shareholders to have a means
of expressing their views on director and executive remuneration’. The OECD (2011)
conclude that ‘aligning incentives seems to be far more problematic in companies and
jurisdictions with a dispersed shareholding structure since, where dominant or controlling
shareholders exist, they seem to act as a moderating force on remuneration outcomes’.

The European Commission

In April 2009 the European Commission announced new guidelines for directors’
remuneration which include, inter alia, performance criteria that ‘should promote the long-
term sustainability of the company and include non-financial criteria that are relevant to the
company’s long-term value creation’; clawback provisions where variable elements of
remuneration were rewarded on misleading data; and termination payments not to be paid
where performance had been poor. However, these guidelines are not intended to be binding
on member states. In June 2010 the EU issued a Green Paper on ‘Corporate governance in
financial institutions and remuneration policies’; one of the issues it consulted on was the
recommendation of a binding or advisory shareholder vote on remuneration policy and
greater independence for non-executive directors involved in determining remuneration
policy. The Commission also consulted on this issue in the 2010 Green Paper on ’Corporate
Governance in Financial Institutions’. In April 2011 another Green Paper, ‘The EU corporate
governance framework’, was issued, with responses invited to various consultation questions.
These included whether disclosure of remuneration policy, the annual remuneration report
(a report on how the remuneration policy was implemented in the past year), and individual
remuneration of executive and non-executive directors should be mandatory; and also
whether it should be mandatory to put the remuneration policy and the remuneration report
to a vote by shareholders. The final outcome of the consultation is awaited.

The Conference Board

In the USA the Conference Board Commission on Public Trust and Private Enterprise was
established to address widespread abuses that led to corporate governance scandals and a
resulting lack of confidence in the markets.
One area that the Commission looked at was executive compensation. The Commission
reported in 2002 with principles, recommendations, and specific best practice suggestions.
The seven principles relate to: the compensation (remuneration) committee and its
 DIRECTORS’ PERFORMANCE AND REMUNERATION 213

responsibilities; the importance of performance-based compensation; the role of equity-based

incentives; creating a long-term focus; accounting neutrality; shareholders’ rights; and trans-
parency and disclosure. The principles serve to clarify several areas and identify that the com-
pensation committee—which should be comprised of directors who are free of any relationships
with the company and its management—should be primarily responsible for ensuring that
there is a fair and appropriate compensation scheme in place. In order to aid them in this role,
the compensation committee may appoint outside consultants who should report solely to the
committee. Performance-based remuneration incentives should ‘support and reinforce the
corporation’s long-term strategic goals set by the board (for example, cost of capital, return on
equity, economic value added, market share, quality goals, compliance goals, environment
goals, revenue and profit growth, cost containment, cash management, etc.)’. In relation to the
role of equity incentives, such as share options, the compensation committee should ensure
that disclosure is made of any costs to shareholders associated with equity-based compensa-
tion such as dilution (the earnings per share after dilution should be shown). Key executives
and directors should be encouraged to build up a reasonable shareholding in the corporation
and hold that shareholding for the longer term.
The Commission’s report is likely to influence policy in many countries, especially those
countries that have already followed the US-style remuneration package and adopted share
option schemes.
In spring 2009 the Conference Board announced the establishment of an Executive Com-
pensation Task Force. They state that:
The Task Force brings together corporations and investors, and governance, legal,
compensation and ethics experts to address one of the most important issues in today’s
business world. The Conference Board’s new Task Force is part of its broader reexamination
of the foundations of the current crisis and its impact on global growth and stability as well
as institutions, business organizations and markets.

In autumn 2009 the Conference Board Task Force on Executive Compensation reported and
provided guiding principles for setting executive compensation, which, if appropriately
implemented, are designed to restore credibility with shareholders and other stakeholders.
The five principles are as follows: payment for the right things and payment for performance;
the ’right’ total compensation; avoidance of controversial pay practices; credible board
oversight of executive compensation; and transparent communications and increased
dialogue with shareholders.

Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)

In July 2010 the USA passed the Dodd-Frank Wall Street Reform and Consumer Protection
Act that amends US requirements relating to executive compensation practices in a number
of respects. From mid-2011 the Securities and Exchange Commission (SEC) required listed
companies compensation committee members to be independent directors. There are new
‘say on pay’ provisions such that the Act requires that, at least once every three years, there
is a shareholder advisory vote to approve the company’s executive compensation, as well as
to approve ‘golden parachute’ compensation arrangements. Whilst the ‘say on pay’ is at least
once every three years, it may occur every year.
214 DIRECTORS AND BOARD STRUCTURE

‘Say on pay’
The ‘say on pay’ was introduced in the UK in 2002 by the Directors’ Remuneration Report
Regulations. It has come very much to the fore since the financial crisis as a tool of governance
activism in the context of expressing dissent on executive remuneration awards. Many
countries including the USA, Australia, and various countries in Europe have introduced the
‘say on pay’ as a mechanism for voting against executive remuneration. In some countries,
such as the UK, the ‘say on pay’ vote is an advisory one (at least for the time being), whilst in
other countries it is a binding vote on which the board must take action.
As mentioned earlier, in the USA, the Dodd-Frank Wall Street Reform and Consumer Pro-
tection Act (2010), under new ‘say on pay’ provisions, requires that at least once every three
years there is a shareholder advisory vote to approve the company’s executive compensation
as disclosed pursuant to SEC rules. The ‘say on frequency’ provision requires companies to
put to a shareholder advisory vote every six years whether the ‘say on pay’ resolution should
occur every one, two, or three years.
Conyon and Sadler (2010), in a study of shareholder voting behaviour in the UK from
2002–7, find that there is
little evidence of widespread and deep shareholder voting against CEO pay. Critics of CEO
pay may be surprised, as one frequently proposed remedy for excess pay has been to give
shareholders a voice. The UK experience suggests that owners have not seized this
opportunity to reign in high levels of executive pay . . . this noted, we do find that high CEO
pay is likely to trigger greater shareholder dissent. This suggests that boards and compen-
sation committees might try to communicate the intentions of CEO pay policies better to
the firm’s multiple stakeholders. Moreover, at present there is little evidence that shareholder
voting dissent leads to drastic cuts in subsequent CEO pay.

Conyon and Sadler do, however, recognize that their study was carried out on pre-financial
crisis data and that there may be a higher incidence of dissent post-financial crisis, especially
in companies that have received financial support from governments or where executive pay
is perceived to be excessively high. Recent evidence does indeed show that institutional
investors are voting with much higher levels of dissent, and more frequently, against executive
remuneration packages in the UK, the USA, and other countries.
Ferri and Maber (2011) examine the effect of ’say on pay’ regulation in the UK. They report that
consistent with the view that shareholders regard say on pay as a value-creating mechanism,
the regulation’s announcement triggered a positive stock price reaction at firms with weak
penalties for poor performance. UK firms responded to negative say on pay voting outcomes
by removing controversial CEO pay practices criticized as rewards for failure (e.g., generous
severance contracts) and increasing the sensitivity of pay to poor realizations of performance.

Conclusions
The debate on executive directors’ remuneration has rumbled on through the last decade,
but with the increase in institutional investor activism, and the scandals and subsequent
collapses associated with a number of large corporations in the UK, USA, and elsewhere, the
 DIRECTORS’ PERFORMANCE AND REMUNERATION 215

focus is well and truly on curtailing excessive and undeserved remuneration packages. The
global financial crisis and the collapse of various high profile banks and financial institutions
has left the market reeling. There is a lack of public confidence in the boards of banks, and
disbelief at some of the executive remuneration packages and ad hoc payments that have
been made to executive directors. There is now an emphasis on payment for performance in
a way that theoretically was present before the global financial crisis but, in practice, all too
often was not. The remuneration committees, comprised of independent non-executive
directors, will come under increased scrutiny as they try to ensure that executive directors’
remuneration packages are fairly and appropriately constructed, taking into account long-
term objectives. Central to this aim is the use of performance indicators that will incentivize
directors but at the same time align their interests with those of shareholders, to the long-
term benefit of the company. Shareholders in many countries now have a ‘say on pay’, either
in the form of an advisory or a binding vote, and seem increasingly active in expressing their
dissent on executive remuneration.

Summary
● The debate on executive directors’ remuneration has been driven by the view that some
directors, and especially those directors in the banking sector, are being overpaid to the
detriment of the shareholders, the employees, and the company as a whole. The
perception that high rewards have been given without corresponding performance has
caused concern, and this area has increasingly become the focus of investor activism
and widespread media coverage.
● The components of executive directors’ remuneration are base salary, bonuses, stock
options, stock grants, pension, and other benefits.
● The remuneration committee, which should be comprised of independent non-
executive directors, has a key role to play in ensuring that a fair and appropriate
executive remuneration system is in place.
● The role of the remuneration consultant is a complex one and there may be potential
conflicts of interest.
● There are a number of potential performance criteria that may be used to incentivize
executive directors. These are market-based measures (such as share price), accounts-
based measures (such as earnings per share), and individual director performance
measures.
● It is important that there is full disclosure of directors’ remuneration and the basis on
which it is calculated.
● There seems to be a trend towards convergence internationally in terms of the
recommendations for the composition, calculation, and disclosure of executive
directors’ remuneration.
● The ‘say on pay’ is a mechanism for investors to express their approval or dissent in
relation to executive remuneration packages and has become widely adopted.
216 DIRECTORS AND BOARD STRUCTURE

Example: AstraZeneca Plc, UK

This is an example of a company that came under shareholder pressure over its executive remuneration
package, and its financial performance and strategy.
AstraZeneca is a global biopharmaceutical company operating in over one hundred countries. Their
primary focus is the discovery, development, and commercialization of prescription medicines for six
important areas of healthcare: cardiovascular, gastrointestinal, infection, neuroscience, oncology, and
respiratory/inflammation.
At 31 December 2011 AstraZeneca’s board comprised two executive directors (the CEO and chief
financial officer) and nine non-executive directors, of whom three are female, one of these being the
senior independent non-executive director. There are no female executive directors on the board. In
terms of international directors, two directors are French, three are from the USA, five from the UK, and
one from Sweden.
There are four principal board committees: audit; remuneration; nomination and governance; and
science committees. The remuneration committee is comprised of four independent non-executive
directors, one of whom, John Varley, is the Chair of the remuneration committee.
In the spring of 2012 AstraZeneca announced that it would be making around 12 per cent of its
staff redundant; yet just a few weeks later, it announced a substantial increase in the pay of its CEO,
David Brennan, to £9.27 million. A substantial part of this came from a long-term incentive scheme
but AstraZeneca nonetheless increased David Brennan’s basic pay and bonus by some 11 per cent.
This was at a time when AstraZeneca’s shares had fallen 13 per cent over the past year, whereas its
peer group had seen increases of more than 4 per cent during the same time. However, John Varley
pointed out that AstraZeneca’s core earnings per share had risen during 2011. There was investor
pressure over David Brennan’s remuneration package at a time when AstraZeneca’s performance has,
in their eyes, been disappointing, and there has also been concern over the company’s strategy going
forwards. In April 2012 David Brennan stepped down as CEO of AstraZeneca after shareholder
pressure to do so.

Example: American International Group (AIG), USA

This is an example of one of the largest American insurers that has received federal government bail-out
money but has continued to pay retention bonuses to its senior employees.
AIG has been kept afloat by more than US$170 billion in public money since September 2008.
A furore broke out after it was revealed that large bonuses were being paid to executives only a few
months after AIG received federal support. The American Federation of Labor and Congress of
Industrial Organizations (AFL-CIO), a voluntary federation of fifty-six national and international
labour unions and representing 11 million members, was one of the groups astounded at the
payouts at a time when thousands are losing their jobs. AFL-CIO were particularly incensed about
these payments, which ‘were in the form of “retention” bonuses to employees of its financial
products division, which sold the complex derivatives at the heart of the company’s financial
troubles . . . AIG’s poor pay practices expose the fallacy of “pay for performance.” The potential
windfalls for executives were so massive they had nothing to lose by taking on huge risks to create
the illusion of profits.’
The CEO, Edward Liddy, asked the senior employees to pay back the bonuses, totalling US$165
million, urging them to ‘do the right thing’. Many of them have now done so.
 DIRECTORS’ PERFORMANCE AND REMUNERATION 217

In recent years, the US government has been looking into how the oversight of executive
compensation might be changed. One area where a significant change has occurred is the introduction
of the ‘say-on-pay’ legislation whereby shareholders have the right to vote on directors’ remuneration.
In July 2010 new ‘say on pay’ provisions were introduced by the Dodd-Frank Wall Street Reform and
Consumer Protection Act 2010, whereby at least once every three years, there is a shareholder advisory
vote to approve the company’s executive compensation.
In 2011 using the ‘say on pay’, shareholders voted overwhelmingly in favour of AIG’s executive
remuneration. Subsequently, in February 2012 AIG reported a US$19.8 billion profit for its fourth
quarter but US$17.7 billion of that profit was a tax benefit from the US government. The company
made relatively little during the quarter from its actual operations. Ironically, the tax benefit will also
benefit employees who are paid based on the company’s performance. However, the US Treasury
Department has ordered that nearly seventy top executives in AIG to take a 10 per cent pay-cut, and
the pay for the CEO was frozen at 2011 levels. Nonetheless, AIG’s CEO is still expected to receive
US$10.5 million.

Mini case study Aviva Plc, UK

This is an example of a company that is itself renowned for its corporate governance activism in its
investee companies but which suffered a defeat of its executive remuneration proposals via the ‘say on
pay’ and also saw the departure of its CEO soon afterwards.
Aviva is the UK’s largest insurer and one of Europe’s leading providers of life and general insurance
with over 36,000 employees and some 43 million customers worldwide.
Its board of directors consists of twelve directors of whom eight are independent non-executive
directors (three of these independent non-executive directors are female, there being no female
executive directors on the board), plus the chairman, the executive deputy chairman, the chief financial
officer, and the executive director for developed markets. There are five key board committees: audit,
remuneration, nomination, corporate responsibility, and risk. The remuneration committee comprises
three independent non-executive directors, one of whom chairs it. The remuneration committee, like
many, seeks the advice of remuneration consultants when setting the pay packages for its executive
directors, and the activities of the remuneration committee note that during 2011 the remuneration
committee approved the appointment of FIT Remuneration Consultants in place of AON Hewitt New
Bridge Street.
During the first part of 2012 Andrew Moss, the CEO of Aviva, announced restructuring plans
which included Aviva Investors shedding more than one-tenth of its workforce; subsequently, in
April 2012 he announced a simplification of the management structure, which saw some of its
most respected executives leaving the company. At around this time, ABI issued an ‘amber alert’
over Aviva’s remuneration report. With investor concern about Aviva’s executive pay proposals
mounting, Aviva announced that it would review the executive pay proposals. Andrew Moss
declined a pay rise of £46,000 but, nonetheless, looking back at 2011, his pay (excluding a
long-term share incentive plan) rose by around 8.5 per cent, whilst Aviva’s shares lost around
one-quarter of their value, which raised shareholders’ concerns of reward for poor performance.
However, the unease from institutional investors was not just about the executive pay proposals
but also about the performance of Aviva in recent years, with share prices falling and Aviva
underperforming compared to its peers. In early May 2012 Aviva became one of the few com-
panies in the UK to suffer a shareholder defeat of its executive remuneration proposals since the
‘say on pay’ was introduced in the UK some ten years ago. Just over a week later, Andrew Moss
resigned from his post as CEO of Aviva.
(continued)
218 DIRECTORS AND BOARD STRUCTURE

Questions
The discussion questions to follow cover the key learning points of this chapter. Reading of some
of the additional reference material will enhance the depth of the students’ knowledge and under-
standing of these areas.

1. What factors have influenced the executive directors’ remuneration debate?

2. Why is the area of executive directors’ remuneration of such interest to investors, and particu-
larly to institutional investors?
3. What are the main components of executive directors’ remuneration packages?
4. Critically discuss the roles of the remuneration committee and remuneration consultants
in setting executive directors’ remuneration.
5. Critically discuss the performance criteria that may be used in determining executive directors’
remuneration.
6. Critically discuss the importance of executive director remuneration disclosure.

References
ABI (2002), Guidelines on Executive Remuneration, ABI, ——— (2009), The Conference Board Task Force on Executive
London. Compensation, Conference Board, New York.
——— (2005), Principles and Guidelines on Remuneration, Conyon, M.J. and Mallin, C.A. (1997), Directors’ Share
ABI, London. Options, Performance Criteria and Disclosure:
——— (2007), Disclosure Guidelines on Socially Responsible Compliance with the Greenbury Report, ICAEW
Investment, ABI, London Research Monograph, London.
——— (2007), Executive Remuneration—ABI Guidelines on ——— and Murphy, K.J. (2000), ‘The Prince and the
Policies and Practices, ABI, London. Pauper? CEO Pay in the United States and United
Kingdom’, The Economic Journal, Vol. 110.
——— (2008), Best Practice on Executive Contracts and
Severance—A Joint Statement by the Association of ——— and Sadler, G.V. (2010), 'Shareholder Voting and
British Insurers and National Association of Pension Directors' Remuneration Report Legislation: Say on
Funds, ABI/NAPF, London. Pay in the UK', Corporate Governance: An
International Review, Vol. 18(4), pp. 296–312.
——— (2011), ABI Principles of Executive Remuneration,
ABI, London. ——— Peck S.I. and Sadler G.V. (2011), ‘New
Bebchuk, L. and Fried, J. (2004), Pay Without Perfor- Perspectives on the Governance of Executive
mance: The Unfulfilled Promise of Executive Compensation: an Examination of the Role and
Compensation, Harvard University Press, Boston, MA. Effect of Compensation Consultants’, Journal of
Management and Governance, Vol. 15, No.1,
Bender, R. (2011), ‘Paying for advice: The role of the
pp. 29–58.
remuneration consultant in U.K. listed companies’,
Vanderbilt Law Review, Vol. 64(2), pp. 361–96. Dodd-Frank Wall Street Reform and Consumer
Protection Act (2010), USA Congress, Washington DC.
BIS (2011), Executive Remuneration Discussion Paper,
September 2011, BIS, London. DTI (2002), The Directors’ Remuneration Report
Regulations 2002 (SI No. 2002/1986), DTI, London.
Combined Code (2008), The Combined Code on
Corporate Governance, Financial Reporting Council, ——— (2003), ‘Rewards for Failure: Directors’
London. Remuneration—Contracts, Performance and
Severance’, DTI, London.
Conference Board (2002), Commission on Public Trust
and Private Enterprise Findings and Recommendations European Commission (2009), Commission
Part 1: Executive Compensation, Conference Board, Recommendation on Directors’ Remuneration, April
New York. 2009, Brussels.
 DIRECTORS’ PERFORMANCE AND REMUNERATION 219

——— (2010), Green Paper on Corporate Governance in ——— (2004b), UK Compliance 2004 with ICGN’s Executive
Financial Institutions and Remuneration Policies, Remuneration Principles, ICGN, London.
European Commission, June 2010, Brussels. ——— (2004c), US Compliance 2004 with ICGN’s Executive
——— (2011), Green Paper on the EU Corporate Remuneration Principles, ICGN, London.
Governance Framework, European Commission, ——— (2006), Remuneration Guidelines, ICGN, London.
April 2011, Brussels.
——— (2010), Non-executive Director Remuneration
Fattorusso, J., Skovoroda, R., and Bruce, A. (2007), ‘UK Guidelines and Policies, ICGN, London.
Executive Bonuses and Transparency—A Research
ILO (2008), World of Work Report 2008: Income
Note’, British Journal of Industrial Relations, Vol. 45,
Inequalities in the Age of Financial Globalization,
No. 3.
International Institute for Labour Studies, Geneva,
Ferri, F. and Maber, D. A. (2011), ‘Say on Pay
Switzerland.
Votes and CEO Compensation: Evidence from
the UK’, Review of Finance, forthcoming. Kostiander, L. and Ikäheimo, S., (2012), ‘“Independent”
Available at SSRN: http://ssrn.com/abstract Consultants’ Role in the Executive Remuneration
=1420394 Design Process under Restrictive Guidelines’,
Corporate Governance: An International Review, 20(1)
FRC (2010), UK Corporate Governance Code, Financial
pp. 64–83.
Reporting Council, London.
Leal, R.P.C. and Carvalhal da Silva, A. (2005), Corporate
FSA (2010), PS10/20 Revising the Remuneration Code,
Governance and Value in Brazil (and in Chile),
FSA, London.
available at SSRN: http://ssrn.com/abstract=726261
Gaia S., Mallin C.A., and Melis A. (2012), ‘Independent or DOI: 10.2139/ssrn.726261
Non-Executive Directors’ Remuneration: A
Lee, P. (2002), ‘Not Badly Paid But Paid Badly’, Corporate
Comparison of the UK and Italy’, Working Paper,
Governance: An International Review, Vol. 10, No. 2.
Birmingham Business School.
Murphy, K.J. and Sandino, T. (2010), ‘Executive pay and
Greenbury, Sir R. (1995), Directors’ Remuneration: Report
"independent" compensation consultants’ Journal of
of a Study Group Chaired by Sir Richard Greenbury,
Accounting and Economics, Vol. 49, Issue 3, pp.
Gee Publishing Ltd, London.
247–62.
Hahn, P. and Lasfer, M. (2011), ‘The compensation of
non-executive directors: rationale, form, and Myners, P. (2001), Institutional Investment in the UK:
findings’, Journal of Management and Governance, A Review, HM Treasury, London.
15(4), pp. 589–601. OECD (2010), Corporate Governance and the Financial
High Pay Centre (2012), It’s How You Pay It, High pay Crisis: Conclusions and Emerging Good Practices to
Centre, London. Enhance Implementation of the Principles, OECD,
Paris.
High Pay Commission (2011), More for Less: what has
happened to pay at the top and does it matter? ——— (2011), Board Practices: Incentives and Governing
Interim Report, May 2011, High Pay Commission, Risks, OECD, Paris.
London. Sykes, A. (2002), ‘Overcoming Poor Value Executive
——— (2011), What are we paying for? Exploring executive Remuneration: Resolving the Manifest Conflicts of
pay and performance, September 2011, High Pay Interest’, Corporate Governance: An International
Commission, London. Review, Vol. 10, No. 4.
——— (2011), Cheques with Balances: Why tackling high Turnbull Committee (1999), Internal Control:
pay is in the national interest, Final Report, Guidance for Directors on the Combined Code,
November 2011, High Pay Commission, London. ICAEW, London.
House of Commons Treasury Committee (2009), Turner Review (2009), A Regulatory Response
Banking Crisis: Reforming Corporate Governance to the Global Banking Crisis, March 2009, FSA,
and Pay in the City, Ninth Report of Session London.
2008–09, House of Commons, The Stationery Office, Voulgaris G., Stathopoulos K., and Walker M. (2010),
London. ‘Compensation Consultants and CEO Pay: UK
ICGN (2003), Best Practices for Executive and Director Evidence’, Corporate Governance: An International
Remuneration, ICGN, London. Review, Vol. 18(6), pp. 511–26.
——— (2004a), Australian Compliance 2004 with Walker, D. (2009), A Review of Corporate Governance in
ICGN’s Executive Remuneration Principles, ICGN, UK Banks and Other Financial Industry Entities, Final
London. Recommendations, HM Treasury, London.
220 DIRECTORS AND BOARD STRUCTURE

Useful websites
www.abi.org.uk The website of the Association of British Insurers has guidelines on executive
remuneration issues.
http://blog.thecorporatelibrary.com/ The website of the Corporate Library, which has
comprehensive information about various aspects of corporate governance including
shareholders and stakeholders; and executive remuneration. (Renamed the GMI blog.)
www.conference-board.org/ The Conference Board website gives details of its corporate
governance activities and publications including those relating to executive remuneration
(compensation).
www.bis.gov.uk The Department for Business, Innovation & Skills website offers a range
of information including ministerial speeches and regulatory guidance.
www.highpaycentre.org The website of the High Pay Centre which contains a range of
documents and reports relating to executive remuneration.
www.highpaycommission.co.uk/facts-and-figures/ The website of the High Pay Commission,
which contains a range of documents and reports relating to executive remuneration.
www.icgn.org The website of the International Corporate Governance Network contains various
reports it has issued in relation to directors’ remuneration.
www.ivis.co.uk The website of Institutional Voting Information Service, providers of corporate
governance voting research. The service has developed from the low key, proactive, but
non-confrontational approach to corporate governance adopted by the ABI. Includes ABI
Guidelines such as those on executive remuneration.
www.napf.co.uk The website of the National Association of Pension Funds has guidelines on
various corporate governance issues.
www.parliament.uk/treascom This website has the publications of the Treasury Committee.

For further links to useful sources of information visit the Online Resource Centre
www.oxfordtextbooks.co.uk/orc/mallin4e/

Part Three case study Royal Bank of Scotland Plc, UK

This case study draws together a number of the issues covered in this section of the book relating to
a dominant CEO, the lack of appropriate questioning of strategy by the board, and perceived overly
generous executive remuneration packages.
The Royal Bank of Scotland (RBS) Plc hit the headlines when it had to be bailed out by the UK
government in 2008 to the tune of £20 billion with the government becoming a 70 per cent
shareholder. The government has also underwritten £325 billion of RBS assets in an effort to stabilize
the bank. In common with various other well-known financial institutions in the UK, USA, and
elsewhere, RBS had been badly affected by the global financial crisis which, ironically, the financial
institutions themselves had helped to cause. Following the initial shock that such a well-known name
needed to be rescued by public funding, came the angry outcry at the remuneration packages being
paid out to top executives, even after the bank had been bailed out.
 DIRECTORS’ PERFORMANCE AND REMUNERATION 221

In 2007 Sir Fred Goodwin, CEO of RBS at that time, received a salary of £1.29 million and a bonus of
£2.86 million, a total of £4.15 million. This package was more than the CEO of any of Lloyds TSB, HBOS,
or Barclays received. Under Sir Fred’s time as CEO, RBS followed two strategic decisions that ultimately
contributed to it incurring massive losses of £24 billion in 2008. The first was that goodwill on past
acquisitions had to be written down, and the second was losses arising from its expansion into investment
banking and toxic assets. The board has been criticized for not standing up to Sir Fred who has been
accused of not only going on a seven-year acquisition spree but also paying generous prices for the
acquisitions. Sir Fred subsequently left RBS after being given early retirement at the age of fifty but with a
pension of over £700,000 per annum, which caused even more anger. Despite requests from the
government asking him not to take this huge amount, Sir Fred initially remained unmoved and legal
enquiries indicated that the terms of the arrangement meant that he could not be forced to pay it back.
However, the annual pension has now been reduced substantially although anger at Sir Fred remains high.
Needless to say, at RBS’s annual general meeting the remuneration report received an 80 per cent
vote against it, clearly displaying the institutional shareholders’ disapproval.
RBS’ corporate governance was criticized as it was perceived as having a dominant CEO combined
with a board comprised of directors who had either been on the board for some years and hence
might be seen as being rather too ‘cosy’ with the CEO, or directors who had limited banking experience.
Lord Paul Myners has viewed bank boards generally as inadequate: ‘The typical bank board resembles a
retirement home for the great and the good: there are retired titans of industry, ousted politicians and
the occasional member of the voluntary sector. If such a selection, more likely to be found in Debrett’s
Peerage than the City pages, was ever good enough, it is not now’.
Following on from the disastrous financial performance in 2008, and the criticism across the board
from angry investors, an angry government, and an angry public, RBS reduced its board size from
sixteen to twelve, the latter including three new non-executive directors who had received UK
government approval. Sir Sandy Crombie, CEO of Standard Life, the insurer, became the bank’s senior
independent director in June 2009, which should greatly have strengthened the RBS board.
The FSA Report (2011) into the failure of the RBS highlighted a number of factors that contributed to
the bank’s downfall and also stated that ‘the multiple poor decisions that RBS made suggest, moreover,
that there are likely to have been underlying deficiencies in RBS management, governance and culture
which made it prone to make poor decisions’. Sentiment against Sir Fred Goodwin continued to run
high and in early 2012 Sir Fred Goodwin was stripped of his knighthood, awarded in 2004 for his
services to banking, as he was the dominant decision-maker in RBS in 2008 when decisions were made
that contributed significantly to RBS’s problems and to the financial crisis.
During 2012 RBS was once again caught up in the executive pay furore, and the wave of shareholder
activism and public sentiment were directed at RBS’s CEO, Stephen Hester, who decided to waive
£2.8 million in salary and long-term incentives.
222 DIRECTORS AND BOARD STRUCTURE

FT Clippings

FT: Trinity Mirror investors

rebel over pay
By Salamander Davoudi, Media Correspondent

May 10, 2012

Investors underlined their dissatisfaction Steve Bennett, shareholder, said:

with the pay culture at Trinity Mirror on “What is going on? When you read the
Thursday as 45 per cent voted against its Mirror it talks about fat cats and
2012 executive pay plan in the latest bonuses. Why don’t you look in your own
example of shareholders taking action back yard? I have no confidence in the
against perceived corporate excess. board. All I can say is that you are fired.”
Sly Bailey, the chief executive who His comments were met with a round of
resigned last week, saw 14.5 per cent of applause.
votes cast against her re-election for the Sir Ian defended her package: “We
time she remains and 17 per cent voted have not been rewarding our people
against Jane Lighting, the chair of the irresponsibly. Our payment structure is
remuneration committee. not out of line,” adding that Ms Bailey
Investors in Trinity have repeatedly would not be getting a pay-off. He said
demanded a substantial cut in Ms that the board had delivered on the
Bailey’s pay in the light of the group’s strategy required.
share price performance. Trinity’s Chris Morley, shareholder and
market capitalisation has dwindled from member of the National Union of
£1.1bn when she joined in 2003 to about Journalists, said: “It has been a
£84m today. Trinity has paid no dividend strategy of despair rather than
since 2008. success and achievement.” The company
Fewer than half of all shareholders announced that in the 17 weeks to
voted for the remuneration report as 15 April net debt was reduced by £24m to
per cent of votes were withheld. £197m. The pension deficit fell by £54m to
Twenty-two per cent voted against £176m.
executives’ long-term incentive plan. Trinity Mirror has forecast that in
With the exception of the outgoing May, revenues would fall 5 per cent
chairman, Sir Ian Gibson, all other year-on-year, with advertising income
directors were re-elected with a majority down 10 per cent and circulation revenue
of 98 per cent or more. down 4 per cent.
Ms Bailey is expected to leave Trinity, Sir Ian said: “This is a secure business,
the publisher of the Mirror and the it is in tough times but it is not in crisis.
People, at the end of the year. She Many of our competitors, if they were
resigned amid investor anger over her not privately owned, would be in crisis.”
£1.7m pay package. “It is false to say that the business in
At the company’s annual meeting 2003/4 or 1989 or even now is as efficient
shareholders were critical of how as it ought to be. It can be more efficient
Trinity had been run and expressed and should be more efficient even now.”
anger over Ms Bailey’s remuneration. The shares rose 3.5p to 33.75p.

© 2012 The Financial Times Ltd.

 DIRECTORS’ PERFORMANCE AND REMUNERATION 223

FT: Shareholders lose patience

on bankers’ pay
By Dan McCrum in New York and Kate Burgess in London

April 20, 2012

Vikram Pandit, Citigroup’s chief “What Citi tells us is that shareholders

executive, turned around this week to find don’t have short memories, they aren’t
that the crowd of supporters he thought he looking at what happened in the last 18
had at his back had melted away. Without months, they are looking at what
an overt campaign or agitation from a happened since 2007,” said Anne
leading activist, shareholders simply Simpson, head of corporate governance
refused to approve his $15m pay package. for Calpers, the largest US public pension
He was not the only one to be shocked fund, which voted against the pay
when over half of the votes cast on pay at arrangements at the bank.
the bank’s annual meeting were against The head of governance at one large,
or withheld. The vote made Citi the first global fund manager, said the Citi vote
big, financial company in the US to have would resonate across the corporate
suffered such a defeat. Patrick McGurn, world, and was a sign of things to come.
general counsel at shareholder voting “This is the second year that US
agency ISS, says the rebellion came out of shareholders have had a say on pay
the blue. “We hadn’t heard any drum beat and they have found their feet. They feel
about pay.” Many companies thought they more confident in expressing their
had filed the rough edges off controversial views—not just about US banks.” In
pay schemes, he says, and pay had fallen part it reflects a broader debate about
down the agenda. But days later, on the pay. In the US attention has begun to
other side of the Atlantic, Barclays bowed focus on the rewards going to the richest
to investor protest at a package for chief segment of society after more than two
executive Bob Diamond that included a decades where incomes for the majority
“tax equalisation” payout of £5.75m. have been static, after adjusting for
Boards looking at their own pay scales inflation.
are now faced with the question of The focus on pay also reflects
whether such shareholder unrest is an regulatory changes introduced last year
aberration, confined to the banks, or if it as part of financial reform legislation.
signifies a more assertive stance from All US-listed companies must now hold
investors that is here to stay. an advisory “say on pay” vote at their
Investors’ tempers have been fraying annual meeting.
for some time. Poor returns are testing Congressman Barney Frank, an
their patience, while politicians are architect of the reforms, says the Citi
increasing the pressure on shareholders vote “will encourage shareholders
to exercise their powers and hold throughout the financial sector to take
directors to account after the failings of their responsibilities seriously. And the
the financial crisis. result should be a reduction in the
At Citi, investors have suffered 90 per excessive levels of compensation to
cent decline in their shares over the past financial company executives.” But
decade. A cash bonus of $5.3m and $8m in anger over remuneration goes beyond
deferred stock and cash for Mr Pandit financial services, focusing concerns
rubbed salt into their wounds. Mr about strategy, management and
Diamond’s take home pay last year rose 25 performance and galvanising investors
per cent to about £25m, all in, when shares in a way that no other issue does, say
in Barclays fell by about 3 per cent. voting and pay consultants.
224 DIRECTORS AND BOARD STRUCTURE

Many companies have consulted Investors say that in the UK, for
investors and changed plans again and instance, no-votes will rise. And
again in recent months to avoid public abstentions and withheld votes will no
confrontation. Two companies that failed longer be used as a way of subtly
to receive shareholder support last year, reprimanding boards. “People now see
Jacobs Engineering Group and Beazer abstentions as a wasted action,” says
Homes, took pains to recraft their pay Robert Talbut of Royal London Asset
packages and both received more than 95 Management and chairman of the
per cent support this year. Association of British Insurer’s
Such votes, even when just advisory, are investment committee. Votes against the
also widely credited with forcing boards re-election of individual directors,
of companies to talk to their owners, and especially those serving on remuneration
it has given investors a way to shape the committees, are also expected to rise.
companies they own more directly by Investors were already expecting a
setting management incentives. set-to at Barclays’ meeting in London
Michael McCauley, head of corporate next Friday. The board has for months
governance for Florida’s public pension tried to justify to investors the £5.75m
fund, says that investors are thinking “tax equalisation” payment and explain
about pay in the context of three to five why Mr Diamond’s bonus was so high.
years. “It’s not just about share price Now Mr Diamond has promised
performance, it’s about the change in pay investors a higher share of profits and
relative to performance.” Even so, some said he will forgo half of his bonus until
boards have remained impervious to calls performance improves. Is it enough?
to link payouts clearly to performance, Standard Life Investments, previously a
warn shareholders. These companies will vocal opponent, now says it will vote for
come under fire at annual meetings this the plan. But several are still threatening
year in a way they have not seen before. to vote no.
Turnouts are already rising, In the US there have been only four
particularly in Europe. In part this is votes against pay packages so far this
because US shareholder groups, which year, but the annual meeting season has
are diversifying overseas, are obliged by only just got under way. Roughly
US law to cast their votes. Meanwhile three-quarters of companies will face
European institutions are on notice from investor votes in the next two months.
politicians, regulators and their clients Unresponsive executives will pay a hefty
to make every vote count. price.

© 2012 The Financial Times Ltd.