March 13, 2012 How best to remunerate NEDs
Non-executive directors (NEDs) are the life blood of a successful board yet the question of how to remunerate them properly is one that is still highly contentious. In recent years, the scope of the role that NEDs are expected to perform has increased, as has the risks they face with the ever-increasing regulatory burdens being put on companies. However, their remuneration is still broadly the same as it was before the financial crisis and some companies are finding it harder and harder to recruit the calibre of NEDs that they need.
Role of Non-Executive Directors
Good quality NEDs are essential to the proper running of a board and the importance of their role has been widely accepted in the UK since the Cadbury Report in 1992. As the Cadbury Report stated, NEDs should “bring an independent judgement to bear on issues of strategy, performance and resources including key appointments and standards of conduct.” In particular they can provide some very specific benefits to a board, including:
- helping to provide a check on the excesses of the executive;
- providing an independent and impartial view on the running of the company;
- bringing a breadth of experience to the board; and
- specialist knowledge beyond that of the executive.
Since the financial crisis, there has been an increased focus on the role they play and their importance in managing risks. Amongst other things, the number of board meetings and committees that they have to attend and prepare for has increased (it’s been estimated that NEDs now need to attend an average of 18.4 meetings per year [ref]Corporate Governance Review 2011, Grant Thornton[/ref]).
Trends in Pay of Non-Executive Directors
Listed companies normally pay their non-executive directors a flat fee but these fees have not been keeping up with the increased scope of the roles. In 2011, the average fee for NEDs in the FTSE 100 was £63,951[ref]per research by Incomes Data Services[/ref] which was an increase of 4% over the previous year. Yet this has failed to keep up with the increasing workload and risks faced by NEDs.
The situation is worse in the FTSE-250 and for AIM listed companies, where the companies cannot afford to pay the same level of fees that the FTSE-100 can and fees have been broadly flat. Yet, in some respects, the role of the NED is even more important in these companies. The smaller companies tend to have less NEDs and less experienced executive directors and therefore more responsibility is put on the chairman, the NEDs and, indeed, the company secretary.
Share Incentives for NEDs
It is generally accepted that NEDs remuneration should not include a performance element as this would potentially hinder their independence and impartiality, a key aspect of their role. However, with the increasing importance of NEDs and the increasing scope of their role, companies are looking at using shares as part of an overall remuneration pacage.
A recent example is Stephen Hester, the chairman of RBS; who was awarded share options as part of his remuneration package. Following public pressure, he waived this award and, when doing so, he noted that it was unusual for a chairman to be awarded share options. This is true, but it is worth noting that he had been brought in to a major bank that was going through a very difficult time. Given this, RBS were presumably struggling with how best to remunerate him. They didn’t want to pay him an excessive wage (especially given the public anger at executive remuneration), yet they knew his role was going to be above and beyond that normally associated with a chairman of a FTSE company. They settled on long vesting share options. It was an unusual decision for a company of the size of RBS but it doesn’t mean it was the wrong one.
RBS would not have been struggling to find the cash to pay Stephen Hester a higher salary (even following the financial crisis), yet for many companies, finding the necessary cash can be a real issue. For smaller companies, share options can offer a very attractive way of increasing the remuneration of its NEDs without eating in to the company’s cash.
Awarding share options to NEDs is not something that should be undertaken lightly. If a company did decide to go down this route, the board, the company secretary and the company’s corporate governance advisers would need to consider all of the factors very carefully.
Normally any share options would have a long vesting period and possibly with escrow provisions included as well. The value of the share options when compared with the other forms of remuneration would need to be balanced and the risks and issues clearly and carefully explained to shareholders. The shareholders will also inevitably want an input into this process as well to ensure that their interests are being protected and they should be engaged at an early stage to ensure that their views are heard.
Remuneration is a difficult and complex area and most boards will have some serious concerns with adopting share options for NEDs. It is not appropriate for all companies and professional advice is needed if it is going to be enacted properly. There are numerous examples of companies who have suffered by having NEDs with serious conflicts of interests and where this hasn’t been properly disclosed to shareholders.
Yet, this doesn’t change the fact that share options can form a vital part to the remuneration for a NED allowing companies to attract the talent they need to thrive and should be seriously considered by boards.