What is fair and responsible in executive remuneration?

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It seems that excessive executive reward will continue to attract push-back from investors. For example, Anglo American recently responded to investor criticism of its executive remuneration policy by announcing it would revise its policy.

Getting remuneration right is not easy

As a result, says Ray Harraway, chair of the Remuneration Committee Forum of the Institute of Directors in Southern Africa (IoDSA), the work of the remuneration committee is critical to a company’s social licence to operate, and thus its sustainability.

Speaking after the launch of the Remuneration Committee Forum’s position paper on fair and responsible remuneration recently, Harraway said that getting remuneration right is not easy. “There are no right or wrong answers, there is no ‘number’ that a consultant can provide you with,” he pointed out. “What’s needed is professional judgment exercised within the context of the organisation and the society in which it operates. I fear that many remuneration committees do not have the skills, or courage, needed to make the right decisions.”

The position paper addresses many of the deep questions that remuneration committee members must ask themselves. They include why remuneration should be fair and responsible in the first place, and what the difference between “fair” and “responsible” actually is.

The problem with pay ratios

A particularly contentious area is the wage gap within organisations. The paper argues that using pay ratios is ultimately not helpful when trying to come to grips with it. The main reason is that the ratio is significantly affected by the organisational structure of the company. For example, a company with both a COO and a CEO would have a better pay ratio than one with just a CEO, while a company that outsources lower level jobs could have a lower pay ratio than a competitor that does not. Similarly, a bank that has more high-skilled workers would have a lower pay ratio than a miner or retailer with large numbers of low-skilled workers.

A better tool could be a pay index which tracks CEO pay, median employee pay and the total shareholder revenue of the company in question. “An important recommendation in King IV is that the remuneration of executive management should be fair and responsible in the context of overall employee remuneration. It should be disclosed how this has been addressed,” says Parmi Natesan, executive, Centre for Corporate Governance, IoDSA.

The problem with pay ratios is part of the larger one of mindlessly using benchmarks to set pay levels. A much better approach, Harraway argues, is for remuneration committees to develop their own methodology but be prepared to communicate its thinking clearly. In general, remuneration committees must effectively communicate their thinking to all stakeholders. Such an approach actually goes a long way towards resolving concerns about fairness. To do so, it is vital that remuneration committee members understand the company’s strategy and how it creates value, in order to link value creation to pay.

“This paper positions company directors and remuneration committee members well to rise to the challenge of one of the most vexing but important questions facing governing bodies today,” says Joanne Henstock, EY executive director and Remuneration Committee Forum member. This guidance provides critical assistance for boards in Southern Africa, where we continue to experience the challenging effects of a deficit of professional directors and mature board leadership skills.”

Fair and responsible pay is available for download.