This is according to the Remuneration Committee Forum established by the Institute of Directors in Southern Africa (IoDSA) and sponsored by Ernst & Young’s (EY) latest paper on managing conflicts and tensions in the remuneration committee.
“Doing what will best serve the interests of the company on whose board you’re serving is perhaps the most important principle when it comes to making better remuneration decisions,” said Ray Harraway, executive director of remuneration services at EY .
“This ‘golden rule’ also lies at the heart of three key factors which, when present in remuneration committees, enable them to make quality remuneration decisions.”
A remuneration committee (Remco) is established to ensure that remuneration arrangements support the strategic aims of a business and enable the recruitment, motivation and retention of senior executives while also complying with the requirements of legislation.
According Harraway, Remco’s are only effective if they are composed of independent directors who are tasked with implementing an effective mandate.
“Such a committee would ideally be composed of at least three non-executive directors, a majority of whom should be the independent non-executive directors. This composition enables the committee to more easily operate independently from management and is the most effective way to reduce and manage conflicts of interest and tensions within the committee.”
However, he added that the independent directors need to be able to challenge management’s views.
“This requires the directors to have a comprehensive understanding of the business, as well as the skills needed to assess the fairness of, for example, the performance measures used in bonus targets,” he said.
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Another important factor in making quality remuneration decisions is implementing a plan that promotes effective engagement with shareholders and that drives transparency.
One of the major tensions within Remco’s is when members have to determine non-executive director’s fees. The paper therefore suggests that executive directors be involved in determining fees rather than relying on benchmark information for fees.
“This is a good strategy since it removes to a great extent the question of conflict of interest.”
Also, when bonus targets are set based on internal measures of company performance, it could raise tension.
“Where a bonus plan hinges on profit targets, a weak Remco, without the right skills or information, will not be able to effectively challenge the numbers, and the required stretch in the targets,” said Harraway.
“It comes down to the business acumen of the individual members, which explains why Remco members are beginning to see their fees increase – even coming in line with audit committees fees.”
The paper therefore concludes that each member of the Remco avoids conflicts of interest, acts in the best interest of the company, take into account stakeholders’ interest and ensure a competent director is selected.