How do we rebuild shareholder trust on executive pay

Risk and reward
1.
2.
.
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Understand the company’s material risks, and
articulate the relevant risk appetite (this can
be, at least, partially achieved through closer
liaison and/or cross-membership bet<strong>we</strong>en the
remuneration and risk committees).
Understand the potential <strong>we</strong>ak areas of the
remuneration system, and map risk against the
remuneration elements. <strong>How</strong> and where are risks
picked up? Are risks reflected in remuneration
when the risks turn bad, or is there sensitivity to
the build-up of risk over time?
If necessary, introduce a small number of new or
amended metrics to better reflect risk.
Provide existing collected risk information to the
remuneration committee when it is determining
incentive outcomes.
The remuneration committee should then judge
performance against targets in light of the risk
information provided. If the committee judges that
excessive risk has been taken during the period
to generate the performance, then performance
outcomes should be scaled back or a greater
amount of remuneration should be deferred for a
sufficient period of time to allow the risks to play out.
For example, two companies may make the same
profit of $1bn, but it <strong>do</strong>esn’t mean they should get
the same STI. Stress tests and probability modelling
may show one company’s profits to be much
more vulnerable to changes in commodity prices,
exchange rates or operational risks. If this is so, the
remuneration committee may judge that company’s
performance to be less sustainable and as a result
decide to either pay less or defer more.
This requires much better information about risk
to be provided to remuneration committees. But
remuneration should not drive risk management. If
risk management information is being created just
for the purposes of remuneration plans, either there
is something wrong with how the company is being
run, or the information being gathered is irrelevant.
Remuneration frameworks will never be a substitute
for good risk management.
Finance or risk functions should work with HR
to produce a report for the remuneration
committee identifying key risks, outcomes
for the year’s profit under identified stress tests,
and problem areas identified through the year.
This information should be segmented (eg by
division) in a way that matches up with the
information the remuneration committee is reviewing
on incentives. Getting the right information,
presented in the right way, in the right place,
and at the right time for the remuneration committee,
is essential to informing discretionary judgement.
Remuneration committees may be reluctant to take
on this role. But business life is complex. It is rarely
possible for performance to be encapsulated in one
or two simple metrics.
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| PricewaterhouseCoopers Executive Remuneration – Fourth Edition 2010