Corporate Governance: Top Executive Compensation and Boardroom Practices

By Atty. Eldrid C. Antiquiera

I. Introduction

The issue of compensation among top executives is one of the most sought after topics in the corporate world – it is both intriguing and exciting as well. This article will focus on how top corporations in the UK deal on the issue of compensation of top executives vis-à-vis the problem of corporate governance. It will likewise touch in passing on directors pay in relation to our corporate standard in the Philippines.

In an article written by Brian Main in 1993, the subject took into account the survey conducted between October 1992 and April 1993 in 24 large UK companies. It found that there are well-defined practices and procedures for the determination of top executive pay in these companies – they have established a so-called remuneration committee.

II. Top Executive Pay: A Governance Issue

There is no question that top executive compensation and even compensation for the board of directors of a corporation is a governance issue for its obviously affects the over-all standing of the corporation and the interest of the shareholders. In the Philippine context, it behooves upon the board of directors of every corporation to safeguard the interest of the shareholders and investors by implementing sound corporate practices as the governing body of the corporation. The board of directors is primarily tasked to exercise corporate powers to achieve maximum benefit for the corporation which will later on redound to the benefit of shareholders and investors.

Is it sound corporate practice to delegate the task of fixing compensation and other remuneration to a remuneration committee composed of non-executives of the corporation? It is said that the success of a company is largely determined by the effectiveness of its board of directors. Strong boards give powerful competitive advantage to corporations regardless of size. This is the essence of corporate governance.

A survey of top corporations in the UK would reveal a common corporate practice of establishing a remuneration committee which is in effect a sub-committee to take charge of determining the reasonableness of compensation and other emoluments of tope executives of the corporation. This sub-committee is composed of non-executives tasked to handle the compensation package of corporate executives and to lay down the guidelines for its implementation.

In the sample given, the average remuneration committee is comprised of five directors almost all of whom are non-executives. The frequency of meetings depend upon how broad the task assigned to the committee is – if the only task is to fix the salary package, the committee may meet once a year. Others may meet every quarter if in addition to the salary package additional remuneration is approved for top executives such as share options, annual bonuses, etc. Usually bonus is assessed in relation to a combination of individual and team performance.

It is said that committees are formed to help the board with the many aspects of its role. Committees are created in aid of good corporate governance. Committees may contribute a lot to board effectiveness if the following guidelines will be observed:

(1) There must be written terms of references specifying among others the objectives, membership, meeting attendance, meeting frequency, authority, duties, and reporting procedures;

(2) Chairmanship of the committees is left to non-executive directors;

(3) The chairman and members of each committee are selected according to skills and experience needed by the committee.

However, certain governance experts have advised that the creation of board committees is not essential to good governance. Effective governance does not require committees. When used inappropriately, committees can in fact confuse the issue of accountability. Thus, the following are suggested in order to avoid inappropriate delegation of tasks to committees:

(1) No committee position that would appear to substitute for the functions delegated to the CEO should be created;

(2) No committee should be allowed to be a board within the board;

(3) The Board Chairman should not chair any committee. All committees should be subordinate to the board.

Nevertheless, there is no doubt that the remuneration committee operates under the Board’s delegated authority and that discussion at the full board level is unnecessary. The general feeling is that such discussion would also be inappropriate as it might lead to junior executives being a position to comment on the pay of their seniors.

Moreover, there is a tension on the reliance on the notion of delegated authority and Guinness v. Saunders which seems to suggest that the board does not have the authority to delegate final decisions to a sub-committee in this manner. In the case, however, the thrust of the judgment by the Law Lord seems to be that of identifying the board as having the power to fix special payments to directors and thus eliminating the possibility of it being proper for the board to delegate such decisions to a sub-committee although general powers of delegation do exist.

III. The Cadbury Scorecard

It is imperative to review the governance mechanism as they impact on top executive pay determination in the twenty-four companies interviewed in context of the recommendations of the Cadbury Report. The following are the relevant recommendations per the Report:

(1) Membership of a remuneration committee comprising wholly or mainly of non-executives and chaired by a non-executive must be established and disclosed;

(2) The Chairman of the remuneration committee must be available to answer questions at any meeting of the corporation;

(3) There must be full disclosure of total emoluments received by the directors, chairman and the highest paid UK director;

(4) Out-performance related component of pay must be treated separately;

(5) Calculation of incentive payments must be explained;

(6) Service contracts must have a maximum period of three years;

(7) Outside professional advice must be made available to non-executives;

(8) Good practice suggests establishing a nominations committee; and

(9) Institutional investors should take an interest in the composition of the board.

Sources:

Corporation Code of the Philippines. Section 23.

Pay in the boardroom: Practices and procedures
Main, Brian G M. Personnel Review Farnborough:1993. Vol. 22, Iss. 7, p. 3 (12 pp.)

Practice-Oriented Handbook on Corporate Governance. p. 28.

Other references:

Blame the Board of Directors
Matthew Budman. Across the Board New York:May/Jun 2005. Vol. 42, Iss. 3, p. 42-46 (5 pp.)

Managerial incentives, monitoring, and risk bearing: A study of executive compensation, ownership, and board structure in initial public offerings
Beatty, Randolph P, Zajac, Edward J. Administrative Science Quarterly Ithaca:Jun 1994. Vol. 39, Iss. 2, p. 313 (23 pp.)