Performance and Reward Management

Performance Management is the strategic and integrated process that works towards the sustained success of organisations by improving the performance of the people who work in them and by developing the capabilities of individual contributors and teams.

Reward Management entails the strategies, policies and processes required to ensure that the contribution of people to the organisation is recognised by both financial (bonuses) and non financial (recognition) means. Reward Management is about the design, implementation and maintenance of reward systems, which aim to meet the needs of both the organisation and its stakeholders.The overall objective is to reward people fairly, equitably and consistently. The main focus of this paper would be the high remunerations of directors. According to the Companies Acts 1985 and 2006, a director is defined as “any person occupying the position of director by whatever name called” – directors are often referred to as company’s officers.

There are many different types of directors:

Managing Director/ Chief Executive Officer (C. E.O)

The managing director/ chief executive officer is responsible for the implementation of strategic plans and policies which have been established by the board of directors.The director takes part and makes decisions in the day to day running of business.

Non-Executive Directors

Non executive directors are not involved in the day to day running of an organisation but assists in the strategic decision making process that is important to the company’s development.

Shadow Directors

These are persons who provide instructions and directions and have the capacity to influence the whole board and therefore the appointed directors’ act upon their instructions.

De Facto Directors

A de facto director performs the functions of a director but has not been officially appointed.A de facto director is a part of the company’s governing structure and engages in the management of the company. The de facto director must submit to the companies act and the duties.

In recent years, directors and senior executives have come under close scrutiny for their high salaries. The topic has become highly emotive and increasingly controversial with director’s salaries being branded as ‘fat cat’ salaries. Questions are frequently asked on the level of pay and the basis upon which pay decisions are made. Many see it as a reward of failure culture going against the objectives of reward management to reward all fairly, equitably and consistently; and are questioning if director’s salaries are linked to the level of performance given.

This paper’s main focus will be the remuneration of directors, as stated above, and aims to show that there is in fact some justification for the high level of pay given to directors.

Role of Directors versus Average Employee

Directors of companies operate at the strategic level while average employees operate at the operational level.The roles of the director and the average employee are vastly different not to mention the level of risk a director’s job entails.

Elements of Directors and Senior Executives’ Remuneration Packages

In order to create a clear bonus scheme, it is essential that targets are outlined and rewards are set at a level that is achievable.

Directors

Basic Pay

This is largely subjected to market worth and approval by the remuneration committee. It can be adjusted if there are market changes or substantial success in company performance.

Bonus Schemes

Over 90% of United Kingdom firms give bonus schemes to directors and executives as cash sums by measuring company performance, individual performance and in some cases bonuses can go up to 90% of one’s basic salary. These are however, short term rewards. Long term rewards tend to take the form of share ownership.

Deferred Bonus Schemes

This is where payment is converted into shares and rewards for performance and loyalty to the company are given consideration.

Practical and Theoretical Problems with Director’s Remuneration

This section will discuss the ‘fat cat’ remuneration of directors in relation to a number of theoretical models of pay and performance. Adams (1963) put forward the equity theory, which states that there should be equal treatment for all in the organisation so that workers will feel a level of fairness, and will be motivated to work towards existing goals since once the relevant performance level has been achieved the reward will be given. In the case of directors remuneration there exists inequity since directors operate at the strategic level they are paid more. Agency theory sees the remuneration contract as one way to ensure that the directors act in the shareholders’ interests. Accordingly, contracts are devised to include an element of performance-related pay, with the performance measure(s) being set so as to coincide with the shareholders’ needs. Agency theory reflects the behaviour of Man as an individual. Other economic theories use market forces as their explanation of directors’ pay.

Proponents of labour market theory (Gomez-Mejia and Wiseman, 1997; Finkelstein and Hambrick, 1996) argue that directors’ pay can be explained in terms of the supply of and demand for top executives. Ezzamel and Watson (1998) refer to the need to pay the ‘going rate’ to executives, in order to motivate and retain them. An alternative economic explanation, human capital theory (Agarwal, 1981; Finkelstein and Hambrick, 1996) would be that the amount paid to a director reflects also the qualities that s/he brings to the job – age, education, qualifications, tenure, etc. However, the main explanation that relates to the individual is equity theory. This is a motivational theory, proponents of which (Adams, 1963; Miller, 1995) argue that employees consider the ratio of their inputs (how hard they work) to their outputs (how much they get paid) and then compare that ratio to a referent, for example another employee, or an individual in another, similar company. Should they conclude from this comparison that they are treated more or less favourably than others, equity theory asserts that they will respond by raising or lowering their work efforts, in order to re-establish equity. The contingency theory claims that there is no best way to organise a corporation, to lead a company, or to make decisions.

Instead, the optional course of action is contingent (dependent) upon the internal and external situation. Several contingency approaches were developed concurrently in the late 1960s. Proponents of contingency theory (Balkin and Gomez-Mejia, 1987; Barkema and Gomez-Mejia, 1998; Finkelstein and Boyd, 1998) argue that for companies to be effective in realising their intended strategies there has to be an alignment of the strategy and the company and the environment in which it operates.In terms of remuneration, this suggests that remuneration policies for directors should reflect the company’s overall strategy. If they do not, the lack of fit is likely to impede the effective implementation of strategy. Tournament theory suggests that agents compete against one another for higher positions in a series of sequential elimination tournaments in the tournament hierarchy. In relation to executive remuneration, executives will compete against one another at respective organisational levels.

In relative terms, high-performance executives will be promoted to the next level, where the next round of competition begins. The more competitors there are for a higher position, the higher the prize is likely to be. The process of identifying and promoting relatively high performers is repeated at all but the top level, thereby allowing organisations to identify the best talent for the higher levels. Executives who do not advance within the organisation will find their prospects for promotion adversely affected. Conversely, winning a tournament improves the executive’s career advancement potential, as there is the opportunity to progress further in the tournaments and earn higher pay. However, as executives move into higher levels, the opportunity to be rewarded more options decreases. In agency theory terms, principals have to provide for lost option value in order to obtain at least the same level of performance as the level from which the executive was promoted.

Current and emerging trends for Directors Remuneration

This section will discuss the trends of executive pay in a number of countries.

The Netherlands

New Dutch legislation on equity-based compensation came into force on 1 January 2009, aimed primarily at carried interest held by private-equity house managers and employees participating in private-equity backed companies. Under the legislation, certain ‘lucrative shares’ and ‘excessive remuneration’, resulting in a yield disproportionate to the capital invested, is potentially taxable at progressive rates of up to 52 percent.

Canada

Additional executive compensation disclosure requirements apply in Canada with effect for financial years ending on or after 31 December 2008.The new reporting requirements are more extensive than the previous rules. Issuers are not, however, required to provide comparative data for periods ending before 31 December 2008. Higher levels of disclosure of information are ensuring that there is a high level of transparency and that codes of best practice are adopted.

These restrictions have relegated the powers of powers of directors so that they don’t abuse them and that their remuneration is set within the governing laws and approaches used to decide on the right amount of remuneration.

Conclusion

Though directors pay has garnered explosive attention many laws and regulations have been put in place to regularise the power and remuneration of directors by increasing the overall compliance of the laws that have been changed and improved. There has now been an increased level of accountability for directors for the transparency and disclosure of pertinent information to all shareholders. Finally, there is now linkage of directors’ performance to pay. With these stipulations in place it can be justified that directors salaries cannot be deemed ‘fat cat’ and are fair and just.