Selecting Your Directors, Paying Them Fairly: Looking at the Work of Nominating and Remuneration Committees

By Annabelle Yip

Partner

WongPartnership LLP

In a booming economy and tight labour market, the attracting and remuneration of talent has been a key issue for many companies. The same forces have been at work for companies seeking to grow their boards. However, in addition to the economic factors at play, tightened corporate governance initiatives have a significant influence on the search and remuneration of directors.

On the one hand, the increased responsibilities and liabilities have resulted in many directors limiting the number of board seats that they take on. On the other hand, companies are having to search in a smaller pool of talent in view of the greater performance expectations that heightened corporate governance has placed on boards.

The procedures for selecting and rewarding directors have also had to undergo a sea change, with an increased focus on transparency and accountability. In other countries, where shareholder activism has been burgeoning and hefty salaries have created a sense of scandal, companies are increasingly being asked to justify their choices and their pay structures. In these countries, private equity funds and other institutional investors too have stepped in to demand greater disclosure from their boards, and have not hesitated to recommend voting against a resolution if they do not agree with it.

While these trends have yet to arrive at Singapore’s shores in a big way, it is nevertheless still useful for directors and companies to take a hard look at how directors are chosen and rewarded. The Singapore Code of Corporate Governance (‘Code’) sets out principles and guidelines for this, and this article will not rehearse the guidelines in the Code. Instead, it will examine the very practical steps needed to transform these guidelines into usable and working policies.

Appointment and Nomination of New Directors

Principle 4 of the Code states that there should be a formal and transparent process for the appointment of new directors to the Board. It also recommends the establishment of a nominating committee, and this is now considered standard practice for most listed companies. However, the Code goes no further in setting out just how the nominating committee is to operate. This is of course reflective of the fact that there is no one-size-fits-all approach, and each company must determine the process that suits its size and needs as well as the functions and responsibilities to be vested in the nominating committee.

Notwithstanding this, many listed companies have established best practices in the nomination and appointment process. For companies looking to formalise and adopt similar arrangements, there can be no better place to start than to examine and adapt these existing methods.

This structuring and formalising process is also important as the Code recommends that a description of the process for the selection and appointment of new directors to the Board should be disclosed (Guideline 4.5 of the Code).

Self-Examination: A Necessary First Step

Any nomination and appointment process should start with a review of the company’s business, and its business plans and goals for the medium-term. This is not simply a question of a software company, say, looking for someone with a technology background. A company who is looking to expand into regions with strong labour protection laws may want someone familiar with dealing with trade unions, or someone with a legal background, or someone who has had experience in the particular jurisdictions. In times of expansion, a company may want someone with experience in mergers and acquisitions; in times of downsizing, a company may want someone who has experience with retrenchment.

Having determined the terrain, the nominating committee should then examine the existing board members. This review process may mean not only looking at their experience, and their skills and competencies, but could also include a review of their personalities, networks and contacts. Examples of skills sets and characteristics that a nominating committee may wish to consider include the following:

• a willingness to challenge management;

• special expertise;

• expertise on global issues;

• an understanding of key technologies;

• external contacts valuable to the company;

• a detailed knowledge of the industry;

• high visibility in the field; and

• a strong ability to represent the company to stakeholders.

The review should be widened to cover not only the board members as individuals, but also their composition as a group. Is the board too heavily weighted in favour of any one discipline? Are all the board members dynamic go-getters who might need a more restraining influence?

Skills and Competencies Needed

The nominating committee will then need to sit down to correlate the information in order to determine the qualities of the person or persons needed to provide a suitably balanced board. A set of skills and strengths should be compiled, distinguishing between qualities that are needed and those that are merely desirable.

Increasingly, a required component of this skills set will be the ability to read and understand a financial statement. This need arises partly from the need to give a negative assurance statement on the company’s interim financial statements under rule 705(4) of the Listing Manual. However, more importantly, it is the result of the Court of Appeal’s decision in PlanAssure PAC v Gaelic Inns Pte Ltd that it is incumbent on even non-executive directors “to at least perform a minimal degree of oversight in relation to the accounts and seek to be regularly apprised of the [company’s] financial affairs”. In this respect, it would seem that while the court will not require all directors to have a detailed understanding of accounting and finance, they should have a basic financial literacy to be able to broadly discern if any irregularities exist on the face of the accounts.

Short-listing Suitable Candidates

With this list, the nominating committee can begin to compile a long list of candidates that on their face meet some or most of the requirements listed. At this stage, the nominating committee should consider whether it would be useful to work with an executive search firm. If this is not the preferred route, the committee should in any event seek to canvas candidates from as many sources as is both possible and practicable. Existing board directors are one good source, but other sources should be explored as well. This helps to broaden the search and ensure that the list is not confined to the persons that board members already know and are friendly with. While collegiality on the board is an important factor in its ability to accomplish results, some diversity and independence will also be needed to avoid the risk of the board becoming an echo chamber.

The long list may now be reviewed in order to narrow the search to a short list of five to ten candidates. As a simple first step, the nominating committee should simply determine if there are any candidates that should be taken off because of any conflict or independence issues. In this respect, regard must be had to Guideline 2.1 of the Code which sets out the circumstances which will preclude a director from being considered independent. The nominating committee should also bear in mind that it has the discretion to determine that a director is non-independent even if he does not fall under any of these circumstances (Guideline 4.3 of the Code). The converse, of course, is also the case.

It is also useful at this juncture for the committee to also check whether any of the candidates is already sitting on too many boards to be able to devote sufficient time to the work of this board. This is in line with Guideline 4.4 of the Code which stipulates that when a director has multiple board representations, he must ensure that sufficient time and attention is given to the affairs of each company. What is too many will depend on the amount of work that is expected from the directors. Larger, more complex companies will likely need their board members to be able to spend more time reviewing documents.

Whether any of the candidates should be removed from the long list due to relationships with existing directors is also something that may usefully be considered at this stage. After all, every new board member that is appointed is also a reason for existing board members to stay or go.

Selection: The Final Step

With this pared down short list, the nominating committee will then need to carry out a detailed due diligence on the remaining candidates. Their track records, references, and profiles should be carefully assessed. It is useful for the nominating committee to seek the input of the chief executive officer at this stage as to his preferences in this regard (although some committees may prefer to seek his involvement at an earlier stage to avoid any last minute setbacks)

It is only finally at the end of this long process can the nominating committee begin meeting and interviewing candidates. If possible, meetings with the chief executive officer and other directors should be factored in as well. Some companies may wish to have the candidate spend some time at corporate headquarters to get a feel for the organisation. After all, both sides will, at the end of the day, be making an assessment of character, commitment, and fit.

Remunerating Directors

Principle 7 of the Code states that there should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors.

The Code does set out some general guidelines on how a remuneration policy should be designed. For example, Guideline 7.1 recommends the setting up of a Remuneration Committee. Guideline 8.1 recommends that the performance-related elements of remuneration should be designed to align the interests of executive directors with those of shareholders and link rewards to corporate and individual performance. However, these general precepts must still be translated into a formalised and structured remuneration policy if they are to be implemented.

As with the appointment of directors, many multinationals and large listed corporations already have established formalised written policies. It is useful therefore to take a look at current methods and practices for determining remuneration.

The Measure of the Man

In most cases, a key issue to be addressed in any remuneration policy will be the measurement of performance. The traditional measures have been numeric: growth in shareholders’ net worth, earnings per share, or increases in market share. Increasingly, however, companies are concerned that such measures focus too closely on short-term gain, and lose sight of long-term strategic performance and sustainability. From a corporate governance and legal perspective, a more holistic approach, incorporating both qualitative and quantitative criteria, and measuring individual performance as well as the collective performance of the board as a whole, has much to commend it as being more in line with the duty of directors to act in the company’s best interests. A strategy that produces a short-term gain but sacrifices the company’s medium- or long-term future could well be contrary to such interests.

Traditional measures are being supplemented with other extra-financial measures. The specific type of extra-financial measure or measures used will depend on the company, its business, its goals, and the composition of the board. For example, some companies use an appropriate measure of customer satisfaction as an extra-financial measure. A company in the construction industry may, for example, use corporate safety performance as an extra-financial measure. Some measures may e applicable more to executive directors than non-executive directors who play no part in management. Measures may need to e developed and tailored according to the particular role of the director in the company. The intent is to determine what areas of performance are critical to the company’s success and to encourage or incentivise their development.

Applying the Measures

Once these measures have been determined, then the remuneration committee needs to consider how much weight should be accorded to them so that they provide a meaningful incentive towards fulfilment. In this respect, linking performance in these areas to benefits such as share options or deferred bonus schemes may be considered as a means of tying in performance with actual real world results. This approach is endorsed by Guideline 8.4 of the Code which encourages the use of long-term incentive schemes.

For extra-financial measures, depending on what is being assessed, companies may prefer to rely on independent third parties to provide this assessment. Customer satisfaction may, for example, be determined by customer satisfaction surveys. Where an aspect of the measurement of performance which impacts on remuneration is peer opinion, independent consultants also provide an important element of discretion and confidentiality.

Putting a Number on It

Regardless of the policies designed, the remuneration will eventually have to be pegged to a number. In determining the appropriate figure, Commentary 8.5 of the Code has this to say: “In setting remuneration packages, the company should be aware of pay and employment conditions within the industry and in comparable companies. But they should use such comparison with caution, in view of the risk of an upward ratchet of remuneration levels with no corresponding improvements in performance.”

A useful place for the remuneration committee to start will be to determine what comparably sized companies in the same industry are paying. In this respect, the requirement to disclose bands of directors’ pay will help the committee to decide on a figure. Executive consultancy firms can also provide useful data, and their assistance may be particularly needed where the comparables are overseas corporations. The remuneration committee will need to decide whether such external expertise needs to be brought in for them to make their determination.

Conclusion

Companies may baulk at the initial effort of putting together such policies for remuneration. However, given the central and guiding leadership role played by the directors of the board, this effort will surely pay off as a well-led, transparent company will be attractive to shareholders and investors.