Non-Executive Director Remuneration – A Quick Review Of Where It Stands

By Kala Anandarajah

Partner

Rajah & Tann

1 Overview

Director remuneration is one of the most difficult issues to handle whether it is at the shareholders meeting or at the board meeting or outside. It is plagued by diverse interest of different stakeholders and constant questioning as to whether the director deserved the director fee he received. Whatever be the case, two things are clear: firstly, the expectations of individuals as directors have increased multi-fold and include greater time commitment, exposure to legal liability and scrutiny by the public; and secondly, regardless of the increased demands on the director, the greater his fees, the time immemorial question of whether he continues to be independent arises. But these are issues for discussion at another time.

This quick article looks specifically at directors’ remuneration, focusing only on the non-executive and independent director rather than the executive director (henceforth any reference to non-executive directors will include independent directors). What the article does make clear is that it is not possible to blindly set fixed fees that nonexecutive directors should draw as they sit on different companies as there are simply too many variances at play. The article also stresses that given the integral role that non-executive directors play in corporate governance arrangements, the fee that is paid to the nonexecutive director must be attractive to experienced and skilled individuals. At the end of the day, it is clear that it is in the interests of all relevant stakeholders that non-executive directors are remunerated appropriately. The old ad-age that you pay peanuts you get monkeys bears reminding, particularly in this day and age, where talent is severely lacking.

Note that this article is not intended to be exhaustive but really one that provides an anecdotal review of the position across select countries.

2 Key Differences Between Executive And Non-Executive Fees

By way of quick comment, as a general rule, executives are paid remuneration in consideration for their full time employment with the company. Director fees are not remuneration in the same way but rather a honourarium that is paid to directors for their contributions to the company. Whilst executive director remuneration need not be approved at a meeting of shareholders as being an expense of the company for salaries, non-executive director fees must be approved at a shareholder meeting. Typically, it is a pooled sum that is approved by the shareholders, and the board than allocates the pool amongst the non-executive directors, depending on the specific role that they play.

3 Are There Standard Fees Recommended That Should Be Paid

A review of major jurisdictions shows that there is no standard recommendations as to what nonexecutive directors should be paid for their contributions in companies. This is because such standards are impossible to set and subjected to numerous differences that exist within a company as well as in the industry. Economic conditions also affect what fees are to be paid from year to year. Nevertheless, what has become clear is that there is a consistent cry amongst various countries that the non-executive director is not adequately compensated. In this regard, studies have at various times been conducted by independent consultancies which suggest that non-executive directors are indeed not being compensated adequately relative to the role played and their legal responsibilities undertaken.

This despite the fact that all recent studies suggest there has been a gradual increase in non-executive director fees over the last four to five years. For example, Watson Wyatt’s 2004 Executive Reward Survey indicates that non-executive director fees have risen by an average 38% per cent among FTSE 100 companies broadly. A year later, a study undertaken by a different consultancy showed that nonexecutive directors’ fees increased twice as fast as other executives in the same year. More recent studies show that the fees have continued to increase at fairly quick rates. The position is no different in Singapore, save that there has been no study of sufficient size to provide us with definitive figures.

What is clear is that save for the trend of increasing fees, there is no consistent rate that is charged across the world.

Typically to analyse whether directors are being adequately compensated, one need only look to the quantum of time that the particular role that director is intended to undertake, the typical compensation such an individual would have drawn if the role was a fully executive one, and build in a discount for the fact that the function to be exercised is more an oversight one rather than a hands on one. This will enable a fair fee to be arrived at for a non-executive director. This is also the recommendation of the Hong Kong Institute of Directors Guide for Remunerating Independent Non-executive Directors. The Guide notes as follows:

In arriving at a rate for computing time-related INED fees, references may be made to:

(1) How external advisers, charge clients for advice and counsel.

(2) The average remuneration of the EDs in the company;

(3) The average of (1) and (2), which amalgamates the above two factors and reflects proximity to market rates and inhouse rates.

Indeed the Hong Kong Institute of Directors suggest that to exercise effective due diligence, it is not unreasonable for a non-executive director to devote a minimum of 100 to 120 hours per year to a company. A Watson Wyatt article titled ‘The Future of Director Compensation in Hong Kong’ written in the third quarter of 2006 picks this up and notes that ‘total director remuneration for 100 hours of service at an hourly partner rate charges by professional advisors of HK$4,000 should be in the range of HK$400,000 per annum.’ The article further notes that in the US, among similarly-sized companies, the annual fee paid to a non-executive director approximates this figure.

For purposes of comparison, a Kon/Ferry-Egan Associates Study titled 2007 Board of Directors Study in Australia and New Zealand notes that non-executive directors at the top 100 companies in Australia and New Zealand are paid an average fee of A$148,939 per year. However, within this average, there are variations and the fees can go down as low as A$54,500. Insofar as the average

fee for a FTSE 100 non-executive chairman is concerned, it is allegedly at over £250,000 a year. As regards non-executives in the FTSE 100, the average fee is allegedly over £60,000. Note that each of these fees are based on transparent calculations of the number of expected days that the individual is to spend working on the company’s affairs.

It is recommended that the broad approach suggested should also be used by Singapore companies. Review the nature of the role the non-executive director is intended to perform, consider the type of individual that is required, then benchmark his fees to the number of hours he is expected to realistically spend working and reviewing the company affairs tasked to him and multiple that figure by the typical sum that an expert in his role would have charged. This is a practical and transparent approach to adopt in determining an appropriate fee to charge.

Section 4 below provides some guidance on the key factors that must be looked at when determining what a non-executive director should be paid.

4 Certain Key Elements In Director Remuneration

Whilst it is not possible to recommend a single remuneration structure for companies to adopt given the vagaries that exist between the different companies within a single country and across countries, it is nevertheless possible to suggest the following broad principles that companies can look to in setting their remuneration:

(a) Existing Policies

Consider the company’s existing remuneration policies, and determine if variations need to be made to this bearing the other factors as set out below. If no revisions are necessary, then any and all remunerations should be consistently set according to the company existing remuneration policy.

(b) Size Of Company

Pay according to the size of the company and the level of expertise required to handle any complexity associated with such size. Typically, the larger the company, the more time an individual would be expected to spend. For one, there would be more meetings to attend, and if the individual also sat on committees, then in addition to the usual board meetings, such a person would also have to attend the committee meetings.

A non-executive director who takes his role seriously would also have to ensure that he prepares in advance for these meetings. A long time experienced director who sits on the boards of a number of listed companies in Singapore says that preparation a chairman of an audit committee preparing for an audit committee meeting should spend at least a day reading up all relevant papers, understanding the financials presented, review the risk issues, if any and ask pertinent questions. Any less time would mean that the individual may not be able to realistically fulfill the task assigned to him effectively.

As evidence that the issue of the size of the company matters is a Kon/Ferry-Egan Associates Study titled 2007 Board of Directors Study in Australia and New Zealand that shows that in in each of these two countries the average non-executive chairman fees across the ‘revenue ranges from $552,796 for those companies in the range of greater than $10 million, to $115,842 for those with revenue in the range of less than $200 million’. A similar range will also be seen amongst Singapore companies broadly.

(c) Nature And Complexity OfBusiness Operations

Tied in to point (a) is the nature and complexity of the business operations. The more complex, obviously the payment must necessarily be higher. Complexity depends on the specific nature of the business, the geographic spread of the business, the nature of unusual risks associated with the business and or the company that needs to be provided for etc.

(d) Industry Considerations

Review the nature of the industry and consider the risk factors associated with the industry. Given the increased risk of workplace injuries associated with the construction or shipping industries, any individual appointed as a nonexecutive director in such an industry must ensure that he pays due heed to seeing how best to assist in directing adequate risk management. Industry considerations would also include the state of the economic conditions pertaining to the particular industry at any particular time. The idea is to benchmark fees amongst similar industries and not simply company size alone.

(e) Qualifications Of Individual Directors

Review the nature of the qualifications, expertise and experience the non-executive director is expected to possess when he is appointed.

(f) Time Expended By Individual Directors

Review the time that the non-executive director will be expected to spend in the company. Here, the approach recommended by the Hong Kong Institute of Directors is one which can work and companies should seriously consider adopting it as an approach.

(g) Role Performed By Director

Consider whether the non-executive director is merely sitting as a director of the board or whether he also sits on any committees, and if so, how many and whether he chairs any of the Committees. Typically, the chairman of the company and of specific committees should be remunerated at a level that is higher that of other directors’ fees to acknowledge the additional responsibilities. See the figures provided under sub-paragraph (b) above for instance vis-à-vis a non-executive chairman and the non-executive director simpliciter.

(h) Fee Structure

Consider a combination of straight out fee payment and some degree of equity payment. The latter will ensure a degree of alignment between the interest of the directors and shareholders. Yet, the trick is always identifying what is the appropriate level of equity. The recommendation is to keep the percentage low. Note that this is different from providing an incentive scheme, whether through share options or otherwise, and the latter is not recommended.

(i) Reimbursements

Do reimburse reasonable expenses of non-executive directors, but make sure that there is clear guidance on what disbursements are claimable and how much.

5 Conclusion

As noted, this article was intended to provide a quick overview of the state of non-executive director fees. It is clear that whilst there has been a gradual increase in the fees that such directors draw, there has been no consistent approach across the world. It is also not evident that a similar increase, or at least rate of increase as in some other countries, has been observed in Singapore. However, given the talent shortage, it is necessary for a long and arduous look to be given to the state of nonexecutive director fees and bring it in line with market forces. The approach of benchmarking salaries not just against that of other directors in comparable companies, industries and other countries, but also against what a full time consultant would have charged on a per hour basis and then working in a discount is much to be lauded and should be adopted. Stakeholders should recognise that without appropriately qualified individuals who will spend the time and dedication, it is the company and eventually the other stakeholders who will suffer.