The case for proper remuneration governance

The remuneration of executives is inextricably linked to corporate governance, as it reinforces corporate culture and reflects the company's strategic priorities. Executive remuneration has, what economists call, an agency problem. Executives are meant to act in the best interests of the company, but they are also in a position to take excessive remuneration. This conflict is meant to be managed by an independent remuneration committee that sets the structure of the pay system and then ensures that the outcomes are defensible.

On the right track?

There are two fundamental principles for remuneration. First, to determine what to pay for (e.g. profit, growth, shareholder value), and second, to understand the quantum outcomes. In this connection, the Code of Corporate Governance states that a significant "proportion of executive directors' remuneration [should be] structured so as to link rewards to corporate and individual performance". The Code's Practice Guidance elaborates that "performance should be measurable, appropriate and meaningful so that they incentivise the right behaviour and values".

Mainboard listed construction company, Lian Beng Group, recently attracted public scrutiny over its remuneration practices.

For the year ended 31 May 2021, the remuneration of its three executive directors was higher than the previous year. Concerns were expressed because this increase was after reporting falls in revenue and profit attributable to shareholders, although total comprehensive income increased. More notably, the company acknowledged that net profit excluding government Covid-related grants was indeed lower, although it explained that the remuneration payable to its key executives included a bonus component that was based on the overall general profitability of the group.

These disclosures bring to mind similar issues six years back. In July 2015, two of the company's independent directors (IDs) resigned over differences in opinion in the computation of the performance bonus of the three executive directors. In particular, whether the profit measure used for calculating bonuses should be before (as per existing contracts) or after (preferred by the IDs) the allocation of minority interests to profit.

Structural concerns

These issues highlight a few structural difficulties that remuneration committees and boards face when considering best practices in remuneration governance.

For one, there can be a concern about how service contracts are designed and implemented for listed companies. These are typically put in place just prior to the initial public offering (IPO) when management (particularly in the case of family-managed and controlled companies) can, in practice, set terms that are more favourable to themselves.

The incoming IDs appointed ahead of the IPO are then tied down into simply administering these contracts. Some of these contracts may not have an expiry date, in which case, the remuneration committee will be further constrained. Even when such contracts have a fixed term, executives will tend to negotiate them upon expiry to ensure their prospective remuneration is not reduced. Remuneration committees are then hard-pressed to change or update these formulaic bonus arrangements later on.

Whilst many companies use some form of profit-sharing formulae for bonuses, these formulae are inherently basic in nature and do not capture or measure the full range of responsibilities, functions or performance of the key executives - particularly balancing short, medium and longer-term objectives.

In addition, this and other cases bring to the fore the issue of the significant subsidies dished out by the government during the Covid-19 pandemic. Investors and market commentators would likely recommend that net proceeds from government grants should be excluded from the performance bonus calculations for executive directors, notwithstanding the bonus formula adopted at the inception of their service contracts.

A corporate governance conundrum

Singapore should want to maintain the position that boards should be free to set executive remuneration with limited regulatory control. But this market freedom needs to be earned, and there are some measures that listed companies and regulators can undertake to achieve better remuneration governance.

First, there needs to be greater disclosure and transparency on remuneration policies, and the relationships between remuneration, performance and value creation. In particular, the Practice Guidance recommends that disclosure also be made of the way that executive performance is measured, including a breakdown of the types of financial and non-financial metrics adopted, why those metrics are appropriate and the way that personal performance is assessed.

Second, regulations on remuneration disclosure which are not mandatory in nature, could be given more teeth and strengthened to raise market standards. As it is, remuneration disclosures are presently among the least complied with provisions in the Code, and Singapore Exchange (SGX) should question companies which fail to disclose in accordance with the the Code.

Third, service contracts for key executives should have limited fixed terms instead of being open contracts. The SGX should not allow any contractual executive bonus arrangements which tie the hands of the remuneration committee.

Finally, remuneration committees can be more active in managing their executives' remuneration arrangements. They should use their discretion to adjust remuneration policies to respond to market conditions as well as ensure that there is adequate remuneration disclosure by the company.

It is only by bringing strategy and pay together that businesses can ensure they reward the actions and behaviours necessary to achieve their strategic goals.

The author is a member of the Advocacy & Research and International Relations committees at the Singapore Institute of Directors.