Risk & Economy » Audit » Corporate governance – A view to review

If there were ever a place where responsibilities are passed swiftly on to someone else, it is in remuneration committees. Yet remuneration, particularly in the US, has a unique power within a company to destroy reputations faster than anything else. That is why the topic is such a hot potato and why whenever the need for a remuneration decision turns up in someone’s in-tray it is off-loaded, generally to someone outside the company.

There are two issues here. First the defensive nature of remuneration committees makes the issue worse. Second, the inevitable use of outside consultants worsens it further. Few people have thought the issues through and modified their practices accordingly, and even fewer have produced a simple formula to keep the critics at bay.

Corporate governance is in trouble, and the trouble stems from the desire to shift the responsibility elsewhere. This is something which ought to be reversed, but which is unlikely to happen. Everyone likes the idea of their own remuneration being as high, extensive and diverse as possible. It is always someone else who has gone too far and brought opprobrium down upon the company.

Former Abbey National chief executive Ian Harley has experienced both sides. He was brought down by the company’s non-executives, and he has since done his own bringing down as a non-exec at Rentokil. Speaking at the last LexisNexis conference on corporate governance, he said: “Remuneration committees have made things worse. There are huge pressures on remuneration committees to use outside consultants. They are intimidated and take shelter in advice.”

And outside consultants are unlikely to come back to a client company and suggest that remuneration levels should be pegged back, lowered, or maintained in a lower quartile. Harley suggests this is partly due to disclosure. Disclosing remuneration turns the process into a round of corporate bragging egged on by the consultants. American investor Warren Buffett was right when he said that external remuneration consultants should trade under just the one name – Ratchet, Ratchet & Ratchet.

Harley believes companies should employ a formula that states the parameters clearly. For example, the people at the top should earn no more than x times the people at the bottom of the company, and everything should fit into that. It would put remuneration consultants out of business and the policy could be defended and explained to analysts, investors and to the general public.

Whether that would work is beside the point. What needs to happen is a serious rethink at a senior corporate level about what people are trying to achieve in this field. It is not going to be effective in the future to simply offload the responsibilities. One place to start would be in carrying out a review of how effective remuneration committees have been in their work.

The Combined Code insists that all board committees be assessed each year. But a recent report by Independent Audit suggests that, while this may be happening, there is no evidence of anything effective taking place. “As far as we can tell,” says Richard Sheath of Independent Audit, “reviews of the remuneration and nomination committees have generally been cursory, if they have been done at all”. His conclusion is a simple: “The apparent absence of life and lack of thinking in this area doesn’t bode well.”

The Independent Audit report covers the whole range of issues and sets a benchmark to guard against criticism of excessive rewards, a lax approach to benefits and perks, and the perception that remuneration policy is applied differently across the company. “A strong remuneration committee will recognise that it can reduce the risk of such damage by setting the tone at the top,” the report says. “By demonstrating its effectiveness at providing good checks and balances, it can have a positive impact on both employee attitudes and shareholder confidence in management and the board.”

The report also quotes Richard Breeden, former chairman of the Securities and Exchange Committee. He described this issue as “the next chapter in the great governance debate”. That may worry corporate boards and, as a result, they may reach for the phone to the lawyers once more. But the issue is simpler than that. Boards need to ensure that remuneration committees are effective at implementing what are really just commonsense policies which are then communicated to the outside world.