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CFA Level I · CFA Level I Exam · Corporate Governance: Conflicts, Mechanisms, Risks, and Benefits

A company's board has 12 members. Its remuneration committee has three members: two independent directors and the CEO's longtime friend, who is an executive of a major supplier. The committee approves a large increase in the CEO's pay with no link to performance. Which action would most likely best improve the committee's effectiveness?

The best improvement is to make the remuneration committee entirely independent and link executive pay to long-term performance. This removes conflicts from supplier ties and friendships and aligns management incentives with shareholders. Letting the CEO decide pay or reducing independent directors would increase the conflict of interest.

  1. AReduce the number of independent directors on the board to speed decisions.
  2. BReplace all members with independent directors and tie pay to long-term performance measures.Correct
  3. CMove approval of executive pay to the CEO, who knows the company's needs best.

Explanation

A remuneration committee should be fully independent, free of business ties to the company, and should align pay with long-term performance. Giving the CEO control over their own pay, or reducing independent directors, worsens the conflict of interest.

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