Can executives award themselves bonuses?

It is commonly reported in the newspapers that executives awards themselves large pay packets.  This sounds like a really bad way to determine the pay of the fat cats - of course, if they can determine what they are paid, then they will award themselves huge bonuses!

Deborah Hargreaves, (Director of the High Pay Centre), like many others, thinks that this a bad way to do things: “it is quite obscene for bosses to continue to award themselves big pay-outs when company performance is mediocre…”

However, this is not how pay is determined for the senior executives. At least not at large listed companies in the UK - i.e. the ones that get in the news for the size of the bonuses.  This fact is sometimes forgotten, but doing so can help to spice up the journalism a little.

So how does it work?

Well, there are four main ‘bodies’ that play a role in the design of senior executive pay at a UK plc

• Remuneration Committee
• Advisers and Remuneration Consultants
• Shareholders
• Executives

 The main one here is the Remuneration Committee - sometimes referred to as the RemCo - and today’s post will look at the role played of this group of directors.

The committee is typically composed of three to five non-executive members of the board.  Furthermore, as recommended by the Higgs Report, “all members of the remuneration committee should meet the test of independence”.  This makes it much harder for former chief executives, and non-executives who have been on the board for more than nine years to sit on the board.  Those who have been on the board for over nine years, may well be the subject of shareholder concern.  For example, ISS have commented about Alison Carnwath’s tenure on the Man Group remuneration committee saying that it "does not consider her to be independent; she remains a member of the remuneration committee, which should be wholly independent".

The committee chairman is the main individual involved in the drafting of the remuneration framework for future years and in the dealing of any issues that might arise over executive pay.

The rest of the committee members support the chairman, but typically have a much smaller time commitment.  Typically their main involvement is in the two or three weeks leading up to a Remuneration Committee meeting when the proposals are discussed and revised.

RemCo meetings will happen roughly six times each year, although if new plans are being drawn up there may well be more meetings (both formal and informal) that take place.

The RemCo papers will be often drafted in advance by one or more of the HR team, the CEO/other Executive Directors and the remuneration consultants - the choice of author depends on the topic in question.  For example, the HR may produce a recommendation but the consultants would be asked to comment on them as well, especially if there is a potential conflict of interest, or an outside and sometimes more experienced perspective is wanted.

The Remuneration Committee members typically do not prepare the papers themselves.  However, the RemCo chairman may indirectly write a paper by working more closely than usual with the consultants in preparation for a meeting.

Some companies publically set out the terms of reference for the committee (Electrocomponents is one such example)

So in conclusion, the fat cats do not simply award themselves large pay packets.  It is the Remuneration Committee which is tasked with approving the executive pay arrangements… and, since 2002 shareholders get to vote as well.  Yes, the vote has not historically been legally binding - but it has still kept the process a bit more shareholder friendly.  Of course, executive pay can still be ‘obscene’, but we need to dig a bit deeper to find out why.  Sorry Deborah.