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Regulating Corporate Directors’ Pay and Performance: A Comparative Review

Document Cited authorities 1 Cited in Related
Vincent
Pages482-506
Author
Published date01 November 2017
DOI10.3366/ajicl.2017.0208
Date01 November 2017
INTRODUCTION

The collapse of banks and businesses in 2008 highlighted the failure of corporate management to prevent inherent risks in financial transactions.1 Despite this failure in risk management2 it seemed as if directors would retain large compensations and pay-outs without any obligation to return or pay back the monies lost under their watch.3 Directors’ remuneration structures have therefore come under greater scrutiny. Remuneration is important because to attract, retain and promote successful corporate activity, management talent must be incentivised and compensated appropriately. Good corporate governance (CG) expects that a board, when considering executive pay, must take cognisance of the challenges in the tasks executed by directors.4 The question is whether directors’ performance always measures up to their often hefty remuneration packages? There is strong evidence that inappropriate incentive structures played a role in the 2008 crisis.5

Australia, the United Kingdom (UK) and Nigeria provide good bases to assess efforts at balancing directors’ remuneration with performance. The three jurisdictions share common-law foundations. Nigeria is a fast expanding hub of corporate activity in the African continent and will provide some insight into the challenges emerging markets face in adopting strategies on executive remuneration. The UK has made significant effort in encouraging good corporate governance through domestic regulation6 and the high performance of companies listed on the Australian Stock Exchange (ASX) suggest Australia is a ‘poster-child’ for financial and CG reforms.7

The definition of corporate governance differs depending on one's perspective.8 However, the Organisation for Economic Co-operation and Development (OECD) states as follows:

Corporate Governance involves a set of relationships between a company's management, its board, its shareholders and other stakeholders. Corporate Governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.9

The Cadbury Report in the UK defined CG as ‘… the system by which companies are directed and controlled’.10 The Australian Securities and Investment Commission11 (ASIC) definition is broken down into two parts

Firstly, it is about the mechanisms by which corporations are directed and controlled; and secondly, it is about the mechanisms by which those who direct and control the corporation are monitored and supervised. That is, it is about mechanisms that ensure those who are in control are accountable.12

 Earlier scholars have also made attempts to define CG.13 Whether theoretical definitions match what obtains in practice today is open to debate, as Bloomfield contends that

much of what currently passes for the theory of corporate governance and which forms the foundation of regulatory policy is based on a description of forces, relationships and actors that holds very little similarity to the way that the real world operates.14

 An aspect of CG which has attracted the attention of regulatory policy is the issue of directors’ or executive remuneration or compensation.15 Executive compensation is a key part of CG because it determines the incentives of the directors not only with regard to size but also to the structure of such compensation packages.16 The compensation package may consist of all or some of the following components: short-term base salary and annual bonus, and long-term stock and stock options, insurance, pension benefits and severance pay.17 For reasons of transparency and accountability there is a need for companies to adopt proper compensation schemes and where (improper) schemes such as the ‘golden handshake’, are used, to have mechanisms for reclaiming these compensation packages via ‘clawback polices’

Section II examines compensation schemes and processes to claw back improper compensation. Section III analyses the different forms of incentive plans, while Section IV considers the broad issue of directors’ remuneration and reforms. Section V evaluates the challenges in measuring performance for remuneration purposes. The article concludes in section VI.

 COMPENSATION SCHEMES

Compensation plays a key role in motivating directors to ensure their efficient monitoring of management and to produce high standards of performance of the company.18 If the key objective of CG is to ensure the sustainability and performance of a company in line with the interests of its stakeholders, it is only reasonable that directors’ compensation packages should be sufficient stimulus for those who are to pursue this objective. We agree that the performance of a company is hinged on its compensation environment as per the size of pay,19 and that compensation has to be appropriately designed if it is to motivate directors towards effective leadership and governance.20

Therefore in determining executive compensation, regard has to be given to the various stakeholders of the company.21 In addition, the size of the board, the size of the company, familiarity between the members of the board, the managers and the major shareholders, and the attraction and retention of executives are all contributory factors in the determination of an appropriate compensation scheme.22 From the results of interviews carried out by Bender and Moir, there must be a balance between the affected parties as regards the compensation scheme of the executives.23 Those who determine directors’ compensation have to make fair considerations as to the interests of others given that the executive is paid from the residual profit of the company and excessive compensation reduces the profit of the company.24 It appears that there is no generally accepted way of determining the appropriateness of executive compensation.25 In practice, the market in which the company finds itself is used as a benchmark in determining executive pay and its levels of bonus and long-term awards.26

For example, the Nigerian corporate environment mainly comprises private, single-leader companies run by heads of families or friends and business remains largely cash-driven. There has been little external influence on the internal activities of companies by government regulation or reform and ‘share options and bonuses are not usually part of non-executive compensation package in Nigeria’.27 Since businesses rely heavily on cash transactions directors are not too interested in non-liquid compensation packages such as Long-Term Investment Plans (LTIPs) in the form of share options and other forms of equity. To some scholars, the environment provides room for greed and fraud.28

Weak regulatory and enforcement mechanisms and the relatively mild punishment that has accompanied previous corporate scandals in the country are also important factors.29 Disinterest or lack of informed awareness of shareholders also mean that they exert little control over directors’ activities. A nascent corporate culture and lack of management expertise by directors with regard to proper board processes and conduct may also be a contributory factor in malpractices related to remuneration.30

In Australia, paying a reasonable remuneration to directors of a company is an exception to the rule requiring shareholders’ approval for payment of financial benefits to a related third party under the Australian Corporations Law.31 The Australian Institute of Directors notes that compensation of directors should remain reasonable for the company and directors with the board deciding what is reasonable.32 Also in Australia, special payments above salary entitlements paid to executives in cases such as retirement, the end of a contract, retrenchment or redundancy were collectively regarded as a ‘golden handshake’.33 The benefits accruing from these packages are significant.34 For instance, five senior executives of the AMP Insurance Holdings Pty Ltd who were responsible for one of Australia's largest ever corporate losses were rewarded with over $AU12 million while the CEO of Southcorp Keith Lambert got $AU4.4 million even though during his tenure the company's shares lost 40 per cent of their value.35 In 2009 the Australian government introduced the new golden-handshake law under which shareholders’ approval is required for ‘golden handshakes’.36 The government has also used tax policies as a tool in clamping down on golden handshakes; any part of a compensation or golden handshake which takes the overall taxable income to $180,000 will be taxed at the normal marginal tax rate.37

Reclaiming Improper Compensation: Clawback Policies

Pauline Renaud has suggested that companies should include clawback clauses or policies in their remuneration policies in the fight to curb reward for failure.38 For this to work, it has to be proved that the executive has misbehaved, or there is material error, or the company has suffered or is suffering a material downturn of performance, or the company suffers a material failure of risk management. In any of these circumstances, the Bank of England proposes that bankers will be forced to give back cash up to six years after they have received or spent it.39 The Financial Reporting Council (FRC) came up with a consultation paper on reforming the UK CG Code and of the three issues on which feedback was expected one was the issue of clawback policies. The Bank of England and the Prudential Regulatory Authority (PRA) have also issued a consultation paper which contains a recommendation that the Remuneration Code should contain a requirement for all PRA-authorised companies or banks to amend employment contracts to enable companies’ to claw back remuneration when it is the right thing to do.40 The RBS Group Plc after the Libor scandal recovered about £302 million by cutting its bonus pools and reclaiming compensation. It appears that the position of the UK is that it would rather claw...

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