Remuneration committees issues for smaller companies

Remuneration committees - issues for smaller companies
Introduction

Australian companies are now faced with a wide variety of guidelines recommending ways to achieve corporate governance "best practice". They include the Australian Stock Exchange Corporate Governance Council's "Principles of Good Corporate Governance and Best Practice Recommendations" and the Organisation for Economic Co-operation and Development's principles of corporate governance.

The AICD believes that the phrase "best practice" is overly prescriptive as it suggests there is only one way to achieve "best practice". The AICD believes that no one size fits all and prefers the phrase "good practice". The phrase "good practice" gives companies especially smaller companies, the opportunity of demonstrating that they achieve governance good practice in a way that suits their resources and structure.

Whilst a number of the guidelines in the market make the point that corporate governance best practice can be achieved in a variety of ways, the AICD believes that smaller companies will come under increasing pressure from investors and other stakeholders, to comply with these guidelines.

The AICD believes that high standards of corporate governance are as important for smaller companies as for larger ones. However, the AICD also believes many smaller publicly listed companies and other companies will find it difficult to comply with some of the guidelines, especially those relating to board committees. This Paper explores the issues that confront smaller companies wishing to achieve corporate governance good practice in the area of board committees, especially remuneration committees.

Board committees

The rationale for establishing board committees is that they can enhance board and non-executive director effectiveness. They do this by enabling boards to distribute their workload more evenly and allowing matters to be considered in greater detail than may be possible in a full board meeting. It is also thought that where sensitive issues such as remuneration or succession need to be considered, an appropriately constituted committee can give these issues valuable independent consideration.

A number of the guidelines referred to above recommend that company boards establish three core governance committees: audit, nomination and remuneration. The most common committee is the audit committee. Audit committees are now mandatory for the Top 500 publicly listed Australian companies. These companies account for approximately 99 per cent of the capitalisation of the approximately 1490 companies listed on the Australian Stock Exchange. A survey of the 2002 annual reports of the Top 200 listed companies found that 99 per cent of the 172 companies surveyed had audit committees, 88 per cent had remuneration committees and 39 per cent had nomination committees. Baker & McKenzie "2003 Corporate Governance Review" Whilst audit committees are fairly widely used in the larger listed companies, smaller companies are less likely to be used in companies below this level.

Issues for smaller companies

There are several reasons why committees other than audit committees are less widely used in smaller companies. The first is that with an average board consisting of 7 members it can be difficult to have sufficient non-executive directors available to sit on committees, which normally consist of 3 members. Source "Boards of Directors Study in Australia and New Zealand", Korn/Ferry International and Egan Associates, Sydney 2003 at page 14 On a smaller board it is simply not possible to populate 3 committees with a cross section of board members, let alone ensure that no one non-executive director sits on all three committees, without appointing more non-executive directors to the board. Smaller companies are also likely to have a larger proportion of executive directors on their boards.

Another factor that can prevent smaller companies from appointing more non-executive directors is cost. Non-executive director's fees for companies in the Top 200 listed companies range from A$48,672 to A$135,000. For companies in the Top 200 to Top 400 fees range from A$31,350 to A$65,000. Source Korn/Ferry International and Egan Associates, Sydney 2003 Report at page 9 Non-executive directors' fees in smaller companies are less than these figures.

Emerging corporate governance best practice seems to favour non-executive directors sitting on fewer boards. The AICD does not believe that it is appropriate to prescribe a maximum number of boards for non-executive directors. However, the AICD accepts that it is likely that non-executive directors will sit on fewer boards than they did in the past. This is a function of the significant increase in the last ten years of the risks and responsibilities for all directors. Smaller companies with fewer resources at their disposal will be competing for a smaller number of non-executive directors. Given the level of fees paid to non-executive directors in smaller companies, it is unlikely that these companies can attract a person who is a full time non-executive director. This also has the effect of limiting the potential candidates for board positions in these smaller companies.

Accepted corporate governance "best practice" requires that audit committees need to be comprised of a majority of members with "significant experience with financial and business matters" See "Audit Committees Best Practice Guide", Australian Accounting Research Foundation, Institute of Internal Auditors and Australian Institute of Company Directors, Sydney, August 2001 or ASX Guidelines Recommendation 4.3. The AICD believes it is likely that the trend requiring non-executive directors to have a particular skill set will be translated to other board committees such as remuneration committees. Anecdotal evidence suggests that while it is relatively easy to find non-executive directors with financial expertise it is less easy to find non-executive directors with remuneration expertise.

The existing pool of non-executive directors, in Australia and other countries, is relatively small and boards need to look at new ways of recruiting non-executive directors. See for example "The Twenty-First Century Board", Anne-Maree Moodie, Sydney, 2001 and "Review of the role and effectiveness of non-executive directors", Sir Derek Higgs, January 2003Ways of expanding the pool include looking for candidates with more diverse backgrounds or looking at candidates just below board level in non-competing companies. See the "Tyson Report on the Recruitment and Development of Non-Executive Directors", London, June 2003Search firms may also be able to assist in identifying candidates that existing board networks may overlook. Once again smaller companies will need to take into account the costs involved in using a search firm. Using a search firm can also involve a potential conflict of interest, given that many search firms charge on a percentage of the fee.

An alternative to expanding the size of the board is for the whole board to act as the remuneration committee. This has the advantage of allowing the whole board to consider remuneration matters. The disadvantage is that it is more difficult to manage any conflicts of interest that may arise from executive directors on the board being involved in setting their own salaries.

Smaller publicly listed or other companies will be at a relative disadvantage because of their smaller resources. The AICD recommends that board remuneration committees be able to enlist the assistance of external advisers. See "Good Practice Guide Remuneration Committees", Australian Institute of Company Directors, Sydney, 2004 This can assist remuneration committee members who do not have remuneration expertise. Again smaller companies will need to take into account the potential costs involved.