Performance-related elements have caused the most controversy in recent years with some directors being awarded a bonus even though their firms have underperformed (and in some cases made substantial losses) or failed to meet or exceed the sector average.
A balance between short- and long-term bonus schemes should be found. The ICGN recommends a minimum bonus period of one year (and not, for example, quarterly) and that bonuses should be based on a percentage of basic salary (or subject to a fixed "cap").
A danger of bonus schemes is the directors' ability to manipulate the target results on which bonuses are based (e.g. revenue, profits). Achieving sales targets, in particular, may result in questionable, unethical practices by directors and employees.
2. Best-Practice Guidelines
The remuneration committee should consider whether directors are eligible for:
·Annual bonuses. If so, performance conditions should be relevant, challenging and designed to enhance shareholder value.
·Benefits under long-term incentive schemes.*
Upper limits should be set and disclosed. There may be a case for part payment in shares to be held for a significant period.
In normal circumstances, shares granted or other forms of deferred remuneration should not vest, and options should not be exercisable, in fewer than three years.
Directors should be encouraged to hold their shares for a further period after vesting or exercise (subject to the need to finance any purchase costs and associated tax liabilities).
Proposals for new long-term incentive schemes should be approved by shareholders and preferably replace existing schemes. Total potential rewards should not be excessive.
Payouts or grants under all incentive schemes should be subject to "hallenging performance criteria" reflecting the firm's objectives.
Challenging performance criteria should:
·relate to overall corporate performance;
·demonstrate that demanding levels of financial performance have been achieved in the context of the firm's prospects and the prevailing economic environment;
·be measured relative to an appropriate, defined peer group or other relevant benchmark; and
·be disclosed and transparent.
Criteria which reflect the firm's performance relative to comparable companies (e.g. shareholder return) should be considered.
"Sliding scales" generally provide a better motivator for improving corporate performance than a "single hurdle" by encouraging exceptional performance.
Rewards under executive share option plans (ESOPs) and other long-term incentive schemes should normally be phased over a set period.
In general, only basic salary should be pensionable.
Consequences of basic salary increases (e.g. on pension costs) should be considered, especially for directors close to retirement.