Markets
Finding the balance on directors’ pay
Stephanie Jacob 
The recent launch of KPMG Malaysia’s Non-Executive Directors’ Remuneration 2017 report
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THERE is a colourful saying that goes: “If you pay peanuts, then you will get monkeys”. The implication is that you get what you pay for and quality often does not come at budget prices.

This logic is often used as the justification behind high remuneration packages awarded by companies to their directors.

A recent KPMG Malaysia report entitled KPMG Report on Non-Executive Directors’ Remuneration 2017 indicates that the remuneration levels for non-executive directors averages at about RM162,000.

This is a 33% increase from the RM122,000 recorded in the 2013 edition of the report and this in turn was 37% higher from the RM89,000 average seen in first version of this report back in 2009.

 

Demands of globalisation

KPMG Malaysia managing partner Datuk Johan Idris noted several factors that has influenced the steady rise in remuneration packages.

“The rising expectations, responsibilities and commitment assumed by a non-executive director have increased their remuneration and these are further accelerated against the intensifying demands of globalisation, emergence of novel technologies and relentless pressure on companies to innovate,” he added.

However, increasing transparency requirements are placing companies and the remuneration levels they offer their board of directors under a microscope. There is an on-going debate over how much such individuals should be paid and what factors should be taken into account when determining pay packages.

This has been particularly robust since the Global Financial Crisis in 2008 when many directors and senior management continued to receive large pay packets despite many structural and financial issues.

Furthermore, the chasm between the levels earned by directors and senior management and the rest of their workforce have also become a point of contention for many.

Finding a balance between attracting talent and fairly compensating a non-executive director in line with their challenging responsibilities while justifying that pay package to shareholders remains a tightrope that many listed companies must navigate.

One of the biggest conundrums for shareholders in relation to director’s pay is if the latter should be paid high fees when a company is recording losses. While undoubtedly an emotional issue, it is important that shareholders are clear on the roles of the various players on the board and management teams, according to experts.

KPMG Malaysia executive director and head of risk consulting Mohd Khaidzir Shahari emphasised that the role of a non-executive director is to provide checks and balances to management.

“The reward should not be based on performance, [if not] the decision-making will no longer be independent and they might favour the decisions made by the executives,” he rationalised.

A corporate governance expert agrees, saying that tying directors’ pay solely to financial performance could cause them to resort to “short-termism” as they chase near-term profits rather than creating sustainable company.

“Curbing directors’ fees is a short-term reaction to crisis, but an investment in the right composition of the board as a strategic asset is a more sustainable long-term strategy,” he argues.

 

Determining remuneration levels

Sunway University Business School economics professor Dr Yeah Kim Leng concurs and emphasises that assessing the board’s performance should be tied to sustainable financial performance over the medium- to long-term period.

“[Remuneration] could include a small portion to reflect the firm’s financial performance but the bulk of it should be based on the extent to which shareholders’ value is created, the accumulation of strategic advantages and sustainability of the firm’s business and value proposition,” he tells FocusM.

When shareholders consider if the compensation packages being offered to their non-executive directors are appropriate, they must take into account several factors, says Yeah.

He points to annual reports of other similar companies in the sector and publications by human resource firms and consultants as possible guides for shareholders and stakeholders.

That said, it is important to remember that it is not a one size fits all, he cautions. “[It] varies across industries typically and reflect differences in firm size and type (ie listed or unlisted companies or government-linked companies), market position, financial performance and business complexity as well as the responsibility of the board of directors,” Yeah adds.

An appropriate amount of remuneration would be one that fairly reflects the non-executive director’s skill set and the input he or she brings to the board. “It [should] also incentivise the directors to contribute effectively in steering and securing the firm’s growth while enhancing shareholders’ value over the long term,” he suggests.

 

Empowering shareholders

The good news for shareholders is that recent Bursa Malaysia rulings are increasing the transparency of how directors’ remuneration levels are reported. Listed companies are now mandated to disclose their director’s remuneration levels on a named basis.

More importantly, they will now also have to disclose the exact amount offered to each director.

KPMG Malaysia’s head of governance & sustainability Kasturi Nathan encourages companies to do even more and insists that the disclosures should not just be limited to what is highlighted in the annual report.

”Detailed disclosures on directors’ remuneration should transcend beyond the circumference of the annual report to also be extended in the resolution contained in the notice to the general meeting which seeks shareholder’s approval on fees and any benefits payable,” she opined.

Furthermore, entities can also better convince their shareholders that pay levels are justified by publishing comprehensive and “meaningful” remuneration policies and procedures. “[This is in] order to allow stakeholders to make an appreciable link between the remuneration framework and objectives of the company.”

She further argued that it is important to reduce the “information asymmetry” in the market.

“The recent reform measures aims to enhance transparency ... [this will help] encourage a culture whereby remuneration is anchored to performance and commensurate with the contribution stemming from skills sets and industry knowledge,” she added.

The changing international scene

AROUND the world, different countries are instituting different laws and procedures to deal with directors’ and executives’ pay in order to ensure that payouts are not obscene or come at the expense of other stakeholders and shareholders.

India: The Indian government has instituted a cap on the remuneration of directors and CEO of any public company to 11% of its net profit in any financial year. Anything higher would have to be approved by shareholders through a special resolution.

United Kingdom: In the UK, companies are required to report annually the ratio of the CEO’s pay to the average pay of the workforce of the country.

Switzerland: A referendum in Switzerland has introduced a prohibition of contractually agreed severance packages (commonly known as ‘golden handshakes’) for board members and executives. The rationale is that such severance payments are made ex-gratia and without any consideration of performance rendered by the individual.



This article first appeared in Focus Malaysia Issue 274.