Remuneration (Compensation) Committees and their Advisers

Background

Executive remuneration (compensation) is always a hot topic, and the remuneration committee is often focussed upon as the key corporate governance mechanism in setting executive director remuneration (although recently the ‘say on pay’ has seen a growth in shareholder influence over executive pay packages as discussed in this blog and elsewhere).
The UK Corporate Governance Code (2012) states that ‘The board should establish a remuneration committee of at least three, or in the case of smaller companies two, independent non-executive directors. In addition the company chairman may also be a member of, but not chair, the committee if he or she was considered independent on appointment as chairman. The remuneration committee should make available its terms of reference, explaining its role and the authority delegated to it by the board. Where remuneration consultants are appointed, they should be identified in the annual report and a statement made as to whether they have any other connection with the company (para D.2.1). http://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-September-2012.aspx

Remuneration consultants

Remuneration committees may draw on the advice of specialist remuneration consultants when constructing executive remuneration packages. The UK’s High Pay Centre (2012) publication ‘The New Closed Shop: Who’s Deciding on Pay?’ http://highpaycentre.org/files/hpc_dp_remco.pdf states that remuneration consultants are ‘normally hired by the remuneration committee. The voluntary guidelines for remuneration consultants state that if they are engaged by the remuneration committee they cannot also work for the executive, whose pay they are determining. The advice they provide varies, but typically includes designing new remuneration plans, and drawing up a comparator group against which the executive pay can be benchmarked’.

Remuneration Consultants Group (RCG) Voluntary Guidelines

The voluntary guidelines to which the High Pay Centre refers were published by the Remuneration Consultants Group (RCG) which was formed in 2009 and represents the vast majority of executive remuneration consultancy firms advising UK listed companies. In fact the RCG’s website states that ‘Any consulting firm, or individual acting as a sole trader, named in the relevant Directors’ Remuneration Reports of at least one FTSE350 company is eligible to become a registered member of the RCG. If a parent firm has separate legal entities acting as Remuneration Consultants then only one of the family of firms may be such a member of the RCG’.

The RCG published the Voluntary Code of Conduct in Relation to Executive Remuneration Consulting in the United Kingdom in 2009 and it is revised every two years , the most recent edition was published in 2011. The Code states that ‘Executive remuneration consultants, comparable with other business professionals, should comply with the fundamental principles of transparency, integrity, objectivity, competence, due care and confidentiality. They should also ensure that, whether or not part of a larger consulting group providing a wider range of services, their internal governance structures promote the provision of objective and independent advice. The full Code is available at: http://www.remunerationconsultantsgroup.com/assets/Docs/December%202011%20Code%20of%20Conduct.pdf
The effectiveness of the Code was reviewed in 2012, see http://www.remunerationconsultantsgroup.com/assets/Docs/Annual%20Review%20including%20Code%20Effectiveness%20Review%20December%202012.pdf In early 2013, following on from the 2012 review, the RCG urged remuneration committees to cite use of the Code to show external audiences that they have followed due process with regard to executive remuneration.

Pros and cons of remuneration consultants

The fourth edition of ‘Corporate Governance’ (Mallin, 2012), discusses the role of remuneration consultants, identifying academic literature in the area highlighting both potential benefits and downsides of remuneration consultants. Various studies are considered but to mention two here, 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 as they encourage incentive-based compensation. On the other hand, 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 ‘evidence 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 consultants for other services are large relative to the fees for executive-compensation services.’

US developments

In the US, the Stock Exchange Commission has approved new corporate governance listing standards for the New York Stock Exchange (NYSE) and the NASDAQ. The standards generally apply to any company with listed equity securities.

The provisions include that, from 1st July 2013, compensation committees have to conduct an independence assessment of advisers including compensation consultants and legal counsel from whom they wish to seek advice. A non-independent adviser may still be used but the independence assessment must still be carried out. There are also new, stricter independence criteria for compensation committee members.
Weil, Gotshal & Manges LLP give a useful summary of the new standards in their Alert ‘New NYSE and Nasdaq Listing Standards on Independence of Compensation Committees and Their Advisers: It’s Time to Prepare’ (January 28, 2013, Weil Alert) http://www.weil.com/news/pubdetail.aspx?pub=11491

Concluding thoughts

The role of remuneration consultants and their potential influence on executive remuneration packages has become the focus of more attention in recent years. The new US standards relating to the independence of compensation committees and their advisers go much further than in many countries, including the UK. Time will tell whether other countries follow suit and introduce tougher recommendations and guidelines.

Chris Mallin
1st February 2013

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