The following principles have been drawn up to help remuneration committees in their development of executive remuneration policies, their practices and their structures.
To find out more about these principles, listen to our podcast on executive remuneration, or read the transcript.
These principles provide a framework designed to aid stakeholders, such as HR Directors/Practitioners, CEOs and Remuneration Committees, in the development of executive remuneration policies, practices and structures. While these may only apply to a small number of individuals, their impact on an organisation can be wide-ranging. This is particularly the case when considering the potential positive influence of incentive structures on performance and behaviour. Furthermore, if it is well managed, executive remuneration contributes to good governance, which can raise the profile of an organisation in its particular sector.
Whilst there are several executive remuneration best practice guidelines widely available, these tend to change periodically and focus on a particular industry or type of company (such as FTSE 100 listed), or have been written from the perspective of a consultancy practice.
These principles represent the CIPD’s view on how executive remuneration should be approached, irrespective of an organisation’s size, sector or business model. They have been drafted to be sustainable over time, rather than as a response to a particular 'hot topic'.
We will first examine the principles of effective executive remuneration, before turning to the individual elements of the remuneration package, then concluding with contractual commitments.
Where reference is made in the principles to the 'Remuneration Committee', this is intended to reflect the persons within an organisation who make executive reward decisions, whether or not they are termed as such.
As a general principle, if an organisation does not have a Remuneration Committee, it should create one consisting of Non-Executive Directors. However, if an organisation does not have these on its governing board, at least one attendee of the Remuneration Committee should be independent of that organisation, that is not an employee or affiliated with it such that his/her judgement could be open to compromise.
Establishing a Remuneration Committee provides a structured governance body through which decisions affecting executives' pay, incentives, benefits and contracts can be taken in the best interests of the organisation and its stakeholders. It enables remuneration issues to be reviewed and considered with a balanced and impartial mind-set.
The ten principles
1. The design of remuneration plans should be clear, appropriately simple and relevant. This helps remuneration be motivational to the executive and transparent to owners and other stakeholders. The structure and level of remuneration should enable the organisation to attract and retain key talent.
2. The mix of fixed and variable remuneration should be commensurate with each executive’s role and level in the organisation. They should not lead to inappropriate risk-taking, for example incentives that drive inappropriate behaviours such as revenue growth to the detriment of profit. Levels of fixed pay should be affordable, even in years of weaker performance.
3. Variable elements of the remuneration package should ensure that the value of the package, in its entirety, will vary with business performance. As incentive schemes reflect the cost of doing business, the financial impact of these should be assessed and budgeted for in advance of any awards occurring.
4. Incentives should reward outcomes that lead to, and reflect, sustainable and measurable value creation.
5. Remuneration Committees should act independently and be able to demonstrate that in approving remuneration policy, they have taken into account the:
- markets(s) within which the organisation operates for talent
- short-term objectives and long-term strategy set by the organisation
- organisation’s structure, financial situation and foreseeable future prospects
- expectations of the organisation’s owners and other relevant stakeholders
- total remuneration package
- approach to remunerating other employees.
It should be stressed that Remuneration Committees take many forms in different organisations and that there is no universal model.
6. It is important that members of the Remuneration Committee should have the appropriate skills, current knowledge, independence of thought and experience of performance management and reward. There should be written terms of reference for the Remuneration Committee and decisions taken by the Remuneration Committee should be written down.
7. The timeline(s) over which performance and value creation are measured should be considered by the Remuneration Committee in designing the remuneration package. They should support and be in alignment with key strategic goals. Timelines which are too long can diminish the effectiveness of incentives and if they are too short can reward performance which is not sustainable.
8. Remuneration Committees should seek to understand the potential cost of remuneration arrangements over the short, medium and long term, assessing these under different performance and value scenarios, taking into account any share dilution impact, if relevant. This analysis is key to ensuring the affordability of variable pay elements.
9. Remuneration Committees and those making remuneration decisions in general, should have access to and, if necessary, call upon appropriate independent expert advice, whether that be external or internal to the organisation.
10. When agreeing remuneration decisions, Remuneration Committees should have the discretion to exercise judgement and take the broader context of an organisation into account alongside its performance, as appropriate. This holistic view may result in decisions being taken which are to the benefit or detriment of those executives in the scope of the Remuneration Committee.
Individual elements of the remuneration package
In determining base pay, the Remuneration Committee should demonstrate that it has taken into account the talent market, alongside the individual’s performance, experience and ‘value’ to the organisation over the longer term. Market data is only one input into the decision-making process and therefore it should not be considered in isolation. The Committee should satisfy itself of the appropriateness of any survey data used to inform a pay proposal and be notified where it may be less robust, for example a small sample.
Where base pay drives other remuneration elements, such as variable pay or pensions, the wider cost implications of any base pay changes should also be taken into account.
Variable payVariable pay is widely used in many organisations, though it may not be appropriate in all cases. Where it is used, the delivery of variable pay should be directly linked to the achievement of strategic, financial and non-financial objectives. Performance measures used in incentives should support the achievement of the organisation’s strategy and be in the interests of stakeholders. These measures should be capable of being assessed on a consistent basis, in a way which is understood by both the executive and relevant stakeholders.
Executives should be able to influence the outcome of the measures which underpin variable pay elements. The measures' targets should be suitably stretching, but not so unreasonable that they are unattainable. There must be a visible link between the level of payout and the organisation’s performance.
Organisations should consider whether deferring an element of any annual bonus is appropriate, taking into account the business cycle, the individual's role in the organisation and the nature of what is being rewarded. Where bonuses are deferred, this can be used as a further link to the ongoing success of the organisation and allow the value of this deferred award to better reflect the ultimate value of the individual’s performance.
Pension and other benefitsAs a general principle, the organisation should understand the current and future cost of its long-term benefit provision, such as retirement plans. There should be a regular review of the external environment to ensure an appreciation of those factors that could impact the organisation’s retirement plans, their value and funding.
Contractual commitments that enhance the executive’s pension entitlement are to be discouraged and should only be entered into if full consideration has been given to the long-term costs and the reputational risk of such a commitment.
There should be a regular review of the benefit policies that cover the organisation's executives, including post-retirement benefits (for example the retention of private medical cover), particularly where these are provided to other employees. This is to ensure that they are flexible and remain fit for purpose. The current and future costs of benefit provision should be understood. No benefits should be guaranteed without time limit.
Contractual commitmentsAn executive’s employment contract / service agreement will always form the basis of any negotiation, and therefore its terms should be crafted with care. The legal position on contractual matters can rapidly change, so it is advisable to seek advice from an employment lawyer before embarking on any recruitment activity or severance involving executives. As a minimum, the Remuneration Committee should understand the terms under which an executive has been employed. It should note any specific contractual obligations, particularly where terms differ from those contained in other executives’ contracts.
SeveranceUK contract law imposes a duty on employees to mitigate their loss in relation to any severance. It follows that executives should be required to mitigate the loss incurred through severance by seeking other employment. Liquidated damages clauses which consolidate the value of various benefits and incentives should not over-compensate the executive. Where possible, the departing executive should receive liquidated damages/payment instead of notice on a phased basis, for example monthly, rather than as a lump sum. These phased payments cease if alternative employment is obtained during the notice period.
As a general principle, the Remuneration Committee should approve any severance decision for executives where discretion has been exercised.
Nicki Demby is a Principal in Towers Perrin’s Executive Compensation and Reward Practice in London. She advises on senior executive pay and the design of short and long-term incentive plans to help businesses deliver their business strategy. Nicki has over 20 years consulting experience and her previous roles include Group Performance and Reward Director of Diageo and Executive Reward Director of Barclays plc. She is a Fellow of the Chartered Institute of Personnel and Development and a member of the Institute of Chartered Accountants in England and Wales.
Rita Faherty is currently Group Director of Reward for Centrica and previously held similar roles at the BBC, Exel, Lucent Technologies and Diageo. Rita has also worked as an independent reward consultant. Her expertise is in executive compensation, UK corporate governance and Remuneration Committee advice and international compensation and benefits. Rita has a business degree from Greenwich University, formerly Thames Polytechnic.
Leigh Harrison began her HR career in 1990, working for Bedfordshire Chamber of Commerce and Industry. Over a nine year period at Exel Plc (now Deutsche Post), she held a variety of generalist and specialist HR management roles. Leigh joined Sainsbury's in 2002, where she currently heads up executive reward, reporting to the Group HR Director. In this role, she focuses on the remuneration and incentives of the Board and top 60. She first became a Chartered Member of the CIPD in 1996, following examination through De Montfort University's Business School.
The authors would like to thank all those who have kindly given up their time to review the principles; their contributions have been invaluable.
Published February 2010 (with minor amendments August 2010)
In August 2010 the CIPD produced further guidance in the form of a set of key questions to help organisations through the process of developing their approach to executive reward: