TO cite one of the world’s oldest and most complete written legal codes, the Code of Hammurabi offered a simple solution for accountability: “If a builder constructs a house and it collapses, killing the owner, the builder shall be put to death”.
At the risk of losing their own lives, it’s easy to imagine ancient builders standing at the centre of newly erected homes to assess the strength of the structure.
The principle is clear – the builder must have “skin in the game” as the builder’s life was bound to the strength of his work.
In the context of board remuneration, we have often heard lamentations that independent directors may lack the moral courage to stand up for minority shareholders, as they do not hold a meaningful personal stake in the companies on whose boards they sit.
To put it another way, independent directors may lack the incentive to take a strong stance against the board members representing controlling shareholders and risk losing their existing remuneration in the form of fees, meeting allowances and benefits.
It is against this backdrop that a South-East Asia-focussed fund management company recently submitted a requisition to move a special resolution at a Malaysian public-listed furniture company.
This proposal suggests that a minimum of 50% of independent directors’ fees should be paid to them in the form of the company’s shares purchased on the open market.
In line with Bursa Malaysia’s allowable parameters, the company proposed that shares purchased from the open market would be subject to a tenure lock-up, preventing their sale or transfer for as long as the director serves on the board.
By aligning wealth to long-term share performance, it is hoped that its independent directors would be encouraged to think like owners and reinforce oversight.
In more mature markets, part payment of fees through shares is indeed gaining traction.
For example, in the United Kingdom, close to 30% of the FTSE 100 companies pay all or a portion of the non-executive directors’ fees in shares.
Over a quarter of the FTSE 100 companies also include a formal shareholding guideline to encourage non-executive directors to utilise a portion of their fees to build up their own shareholding.
In further lending credence to this form of remuneration, the United Kingdom’s Financial Reporting Council has set out that in the Corporate Governance Code that in some circumstances, alternative approaches to the remuneration of independent directors are desirable.
Closer to home, selected major companies in Singapore, including a leading financial institution, have also embarked on a structure that enables share-based fee payment.
Given the positive movement towards adopting the model of providing part payment of fees through shares, it is important to focus on the implementation mechanism within the Malaysian context.
The success of this approach largely hinges on the ability to incentivise independent non-executive directors to have a stake in decision making, and yet not be impaired in terms of independence.
The first key aspect of the implementation mechanism is determining the proportion of fees that may be paid in shares without comprising the independence of independent directors.
To this end, there is an overarching objective criterion in listing requirements of Bursa Malaysia which states that an independent director should not be a major shareholder of the company.
Therefore, an independent director generally cannot possess more than 10% of the shareholding in the concerned public listed company.
In cases where such person is the largest shareholder, a lower threshold of 5% in shareholding would apply.
Listing requirements
Beyond the said percentage of shareholding and as an additional measure of good governance, companies may also take cue from the monetary sum of RM1mil, i.e. the upper limit of the listing requirement’s consideration for past services that an individual may have rendered to the company prior to becoming an independent director.
As such, in devising the percentage of fees that should be paid in shares, companies may make a general deduction by taking into account the fact that the accumulated limit at the end of independent director’s tenure (which is typically nine years) should not exceed RM1mil in the value of shares.
In infusing a commercial consideration to determine proportion of shares that should form the payment of fees, companies may also account for the competitiveness in the existing fee base.
To avoid reticence from independent directors by proposing an adjustment into the existing cash structure of their low fee base, companies may instead consider factoring future increases in the fee via shares.
However, this exercise must only be undertaken if the proposed increase is justifiable and should be anchored on the conduct of a data-driven remuneration benchmarking review that is typically undertaken once every three years.
Timing, manner of granted shares
Another crucial aspect to note relates to the timing and manner in which the shares can be granted to the independent directors.
It is important to underscore that this process can be directly managed and administered by the company.
In this regard, the company may consider purchasing the shares in an open market over a fixed period of time to cushion the impact of price volatility and then transfer the shares to the central depository system accounts of the independent directors.
At all times, it is important to be guided by rules surrounding the black out period and insider trading.
While tenure lock-up conditions are permissible, it is worthy to iterate that the crediting of shares should not be tagged to any performance related conditions of the company.
Further to being disallowed by Bursa Malaysia, this may lead to the creation of perverse incentives to engage in risky short-term actions at a particular point of time.
The third key implementation aspect pertains to the conditions surrounding non-provision of shares and the ability to clawback.
Generally speaking, companies may not want to create any differentiation and accord all the individuals within the cohort of independent directors with the same entitlement.
However, for practical purposes, companies may want to delay the provision of shares for newly-appointed independent directors during the year until the position is confirmed by way of an election at the ensuing general meeting.
As for the ability to clawback, similar conditions should apply as with the other components of remuneration in the form of cash.
In order to avoid unwarranted complexities, the clawback for provision of shares should be tied to the number of shares rather than the market value of the shares.
Overall, the desired impact of aligning the interest of the independent directors and the long-term interest of the company through part payment of fees in shares can only be achieved if thoughtful consideration is given to the design and implementation of the remuneration policies and procedures.
As Richard Moriarty, the chief executive of the Financial Reporting Council puts it, “companies can take varied approaches to structuring remuneration, provided they preserve director independence and are transparent with shareholders about their decisions.
One size does not fit all, so, good governance is about finding the right approach for your company”.
Kasturi Nathan is controls assurance partner, Deloitte South-East Asia and Krishman Varges is controls assurance director, Deloitte South-East Asia. The views expressed here are the writers’ own.
