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1. Introduction

This survey was carried out amongst the member of the ITNEA in July 1999. The survey sought to see how the remuneration of non-executive directors in the IT sector has changed and is likely to change over time. While the remuneration values change with time it is felt that this survey has data that is valuable for a number of years.  This role has developed following the Cadbury, Greenbury and Hampel committees’ reports.  An update survey is in progress with a high reponse from ITNEA members in 2005.  The results are expected to be published by the ITNEA by the end of Q2 2005. 

With the requirements for companies to have audit, remuneration and nomination committees largely or totally made up of non-executive directors, the role of the non-executive director is expanding and becoming more time-consuming. There is therefore a growing awareness of the importance of non-executive directors, not only in the traditional area of corporate governance but also for their strategic contribution in helping companies grow and deliver good returns for their shareholders. This is particularly important for young and rapidly growing companies, such as those often found in the IT sector.

Given these changes in the non-executive director's role, it is perhaps not surprising that there have been various debates about their contribution and how this should be reflected in their remuneration. This raises questions of both fee levels and whether their remuneration should be linked to their performance, as is the case with their executive counterparts.

This survey looks at the remuneration of non-executive directors in the UK IT Sector and examines the views of these directors on pay, performance bonuses and the payment of part or all of their remuneration in shares or share options. The summary is followed by a discussion of some of the issues arising from the survey results.  Further information on seeking new non executives and chairman can be seen at NED Search

 

2. Summary of Survey Findings

Survey Sample

The survey was sent to over 250 directors, over a third of whom responded (81 responses). The came from 56 non-executive directors and 25 non-executive chairmen, covering 62 public and 19 private or unspecified companies. 47 respondents were in companies with a turnover of £1-50 million, 12 in £51-100m, 14 in £101-250m, 5 in £251-500m, and 2 in companies with a turnover above £500m.

 



Remuneration Mix

Of the 81 non-executive directorships surveyed, only 11% currently receive shares or share options as part of their compensation, and only 7% receive any bonuses, 6% based on company performance. The overwhelming majority (93%) received no bonuses at all, and none received bonuses based on their own specific performance. There was a noticeable difference between chairmen and directors in the question of share-based rewards: 20 % of chairmen receive these as contrasted with only 7% of directors. However there was no real difference with regard to bonuses – the figure was 8% and 7% respectively.

However, over half of the non-executives surveyed (59%) believed their package should include options and/or shares. This is driven by the feeling that non-executive fees are low for the expertise, time and responsibility involved. Shares or options provide a cost-effective means of increasing the remuneration so long as the company (with the non-executive’s help) performs well. Only 2% disagreed with giving options to non-executives.

Despite the absence of shares from the remuneration package, the survey revealed that 68% of respondents felt they were encouraged to hold shares in the company. If, as the survey shows, companies are actively encouraging share ownership amongst non-executive directors, pressure will mount on these companies to provide non-executives with beneficial means of acquiring shares. Whilst they can buy shares in the market for public companies, this is not possible with private companies.

It is interesting to note that a recent Pearl Meyer & Partners survey in the US showed that 95% of external (ie: non-executive) directors receive shares or share options in addition to fees. The US fee levels roughly match the level of fees paid in the UK (see Fee Levels below). Ten years ago only 25% of US external directors received shares or share options, so the increase to 95% is a dramatic and recent shift. It remains to be seen if the UK will follow suit, though many non-executive directors clearly feel that this would be justified as a fair return for their contribution.

Bonuses

The survey clearly shows that bonuses are a rarity; 93% of non-executive directors do not receive any form of bonus. The survey then asked what changes, if any, respondents would like to see to NED remuneration in future. There was no expressed desire to provide non-executive directors with cash bonuses – all of the comments were either for higher fee levels or share and share option schemes. Shares are felt to be a better way of aligning directors’ interests with those of the shareholders, providing a fair reward for non-executive influence where it is difficult to provide meaningful performance objectives for cash bonuses.

Fee Levels

The average level of fees in the 81 directorships was £25,476 for a time commitment of 29 days, with the average chairman’s fees being £44,520 for 47 days and the average non-executive director’s fees being £16,974 for 21 days. This mirrors the average cash compensation for US IT non-executives of $41,081 (approx. £25,516), although 95% of US non-executives also have stock based remuneration.

There was a wide spread of fee levels, from £1,440 to £150,000 per annum, but these closely matched the time commitment spread (from 6 days to 160 per annum). The effective fee level per day was on average £976 (chairmen £1,064, directors £937), with a fairly tight spread. The maximum effective fee rate per day was just over £2,000.

The following table looks at the fee element of non-executive director’s remuneration. In the UK this is over 90% of the total value received:-

	Chairman / NEDs	Median fee per annum	Range
Quoted	Chairman	£35,000	£15,000 to £150,000
	NEDs	£18,000	£1,500 to £30,000
Unquoted	Chairman	£24,000	£15,000 to £30,000
	NEDs	£12,000	£10,000 to £23,500

The method of payment of these fees was predominantly on a retainer basis (88%) with the balance of non-executive directors’ fees paid for attendance at board meetings and other corporate committees.

Benefits

Not surprisingly, considering the part time nature of the non-executive role, the vast majority (78%) do not receive any additional benefits such as pension, company car or other benefits typically included in the executive director’s remuneration package.

The breakdown of benefits received by non-executive directors is shown in the following chart. The most common extra benefit is secretarial support, mostly provided for chairmen as opposed to non-executive directors.



Who Sets the Remuneration Levels?

Remuneration levels are of course agreed by the Board, but the survey asked who does the work to set the recommendation. Overall, in 23% of cases it is the Remuneration Committee, in 46% of cases it is the Chairman, 22% of the time it is the Chief Executive, 2% the FD, 1% the Human Resources Director and 4% of the time ‘Other’. As would be expected, the overall breakdown is different when we look at the figures for chairmen vs non-executive directors: the Chairman takes the lead far more often in the case of setting fee levels for non-executive directors, and the remuneration committee/chief executive dominate in setting the chairmen’s fees.



Most companies (65%) review non-executive fees on an annual basis, with 14% reviewed at 2 years, 6% at 3 years and the remainder ‘irregularly’, ‘unspecified’ or ‘never’.



What Time Commitment is Required?

The following charts show the average number of days worked by the chairman and other non-executive directors, and how those days were spent.



Comparison With Other Sectors

The majority of non-executive directors (79%) in the UK IT sector felt that their remuneration was comparable with other sectors in the UK. 6% felt the remuneration was lower and 4% felt is was higher than in other sectors.

Expertise Contributed to the Board

Non-executives felt that they bring a variety of skills and experience to the Board. Specifically mentioned were IT sector expertise (51%), financial expertise (41%), strategic and operational management expertise (36%), legal (9%) and HR (2%), with many directors highlighting 2 or 3 skill areas as their contribution.



3. Discussion Of Issues Arising From The Survey

The following notes are brief pointers to the issues arising on the questions of shares or share options as part of the non-executive’s remuneration package. ITNEA and Inbucon would be pleased to receive any feedback on these points so that the discussion can be moved forward, as there is clearly growing tension on the question and at some point a new consensus will have to be reached. Market forces will get there eventually, but perhaps through discussion there is a better way.

The Cadbury report (1992) on corporate governance concluded that non-executive directors should not receive share options as this might jeopardise their independence. The Hampel Committee agreed, citing the potential benefits arising from share options as inappropriate for the remuneration of non-executive directors.

However, the Hampel Committee did not have the same issues with the payment of non-executive directors’ fees in shares:-

The ABI do not object to the payment of non-executive directors in shares for listed companies, as long as there is no element of performance associated with the provision. The ABI do object to the provision of share options to non-executive directors, as they also believe this could jeopardise their independence, possibly putting short term gains above the long term development of the company.

As a result there are currently substantial external issues to paying non-executive directors in the form of share options or providing performance linked bonuses. These restraints do not apply to private companies which have a greater degree of flexibility in structuring their non-executive directors’ remuneration packages.

Share Options for Non-Executive Directors

With the pressures outlined above, it is not surprising that general practice is not to grant share options to non-executive directors. This can be seen from our survey’s findings, where only 11% of the non-executives receive shares or share options.

However we do not agree that options are an inappropriate way of remunerating non-executive directors of the company. Why should non-executive directors not be rewarded if the value of the company’s shares increases? One questions the value of non-executives’ advice if it does not result in the long-term improvement of the performance of the company. The Hampel committee was concerned that options would provide too much leverage in the returns for the non-executive, but surely this is a matter of setting the number of options to reflect a fair level of gearing for the time and responsibility involved?

For many, the fundamental issue around the payment of non-executive directors in the form of share-based compensation is their view of the role of a non-executive director. The traditional view is of someone who is independent of the company’s executive directors, is uninfluenced by any substantial financial interest in the company, and who can therefore bring an impartial judgment to the issues facing the company and act as an important counter-balance to its executive directors. Compare this view with the popular reasons advocating executive directors’ participation in share-based incentive plans, ie: to align directors’ interests with that of the shareholders’ and to provide a fair reward for the time and responsibility of the job, geared to the underlying financial performance of the company.

The support for performance-based non-executive compensation reflects a feeling that remuneration levels for non-executive roles are low. There is a desire to move towards US practice, where 95% of non-executive directors in high technology companies receive stock-based remuneration, according to a recent Pearl Meyer & Partners study. Interestingly, 48% of US high technology companies positively require non-executive directors to own stock.

The divergence between US remuneration practice and UK practice always produces tension in international companies who have a mixed executive team. In executive remuneration there are also marked differences between the UK and US in the remuneration levels and the size of share-based rewards received. In general, US executive salaries are higher than their UK counterparts and their share-based awards can often be significantly higher. The greater use of options as a part of an American IT executive’s total remuneration package and the general requirement for US executives to build significant shareholdings in their company (normally multiples of base salary) slants US executive remuneration towards share-based arrangements. The practice for US executive directors has had a knock-on effect on the packages provided to non-executive directors in the US, hence the high level of share-based compensation for non-executive directors.

However, it must be noted that one of the main drivers in the US in relation to the provision of share-based compensation has been pressure not to provide non-executive directors with pensions. Share plans have, therefore, often been used as a pension ‘substitute’. It has never been market practice in the UK to provide non-executive directors with pensions.

Recruitment and retention are cited as reasons for rewarding executive directors with share-based compensation. This argument is beginning to apply with non-executive directors, as the IT sector becomes more and more internationally competitive and the choice of market to float on (and therefore to some degree the regulatory regime) becomes a more international choice.

Many of the arguments for and against providing shares options as part of the non-executive package can also be made for and against providing shares. However there are some extra considerations:

• Shares can be provided as a straight exchange for some or all of the fees. This is uncontroversial.
• The provision of shares in this way focuses the non-executive on the company share price, as would options, but possibly does not lead to quite the same short term pressures since there is not the same level of leverage in their value to the holder.

If shares are considered as part of the package, there are some technical considerations that should be borne in mind:

• Most non-executive directors are not employees of the company for whom they provide their services. Therefore, exemptions from the provisions on financial assistance and the financial services acts for employee share schemes would not apply to any arrangement to provide non-executive directors with shares.

• The sacrifice of any fees to which the non-executive director is entitled in exchange for the shares should be made clear, avoiding any question of a gift of the shares.
• The company may wish to impose holding requirements in respect of the shares provided.

• The company’s articles must allow directors to be paid in shares.

• Any limits on how remuneration can be provided to directors must be checked.

• The company must have sufficient net assets and the payment by the company for the shares must not materially reduce its assets.
• The statutory requirements for listed companies and Stock Exchange disclosure requirements in respect of directors’ shareholdings apply to non-executive directors, as do the restrictions imposed on directors during close periods.
• Contracts for services held by non-executive directors may need to be amended to provide for payment of fees in the form of shares.

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