Remuneration Committees are struggling to maintain their independence from their CEOs and are adopting increasingly expensive, short-term reward strategies according to the latest Manifest and MM&K Total Remuneration Survey.
The Executive Director Total Remuneration Survey 2011 examines the latest crop of remuneration reports of UK companies finding little link between remuneration, performance and shareholder value. Although the median FTSE 100 CEO remuneration was up 32% to £3.5 million in 2010 over 2009, the FTSE100 index only rose 9% over the same period.
Looking over a twelve-year horizon it finds that despite flat share prices CEO remuneration has quadrupled.
Short-termism rules
The survey identifies a shift from longer-term incentives (typically over three years) to annual bonuses, mirroring the approach that caused so many problems in the banking sector. Furthermore, as most remuneration strategies now involve the use of Long Term Incentive Plans (LTIPS), reward horizons have shortened to only three years. A decade ago, when share options were the favoured long-term incentive, the horizon average was seven to ten years.
This ‘management myopia’ is accentuated among larger companies whose complex schemes contain multiple reward thresholds. This means that the typical CEO enjoys rewards for even the most basic levels of performance regardless of whether they attain an ‘exceptional’ outcome for the company with many requiring, to vest the maximum award, only EPS growth of RPI plus 9% p.a.
Deferred Bonus
The survey has analysed deferred bonuses in detail for the first time. Deferral of bonus has become increasingly common. The Walker Report (2009) strongly recommended this for the financial sector, however the practice had already become increasingly prevalent in the non-financial sector well before that. Almost three quarter of the FTSE 100 companies are estimated to have a deferred bonus plan and just over half of the FTSE 250. Mostly these plans have been introduced at that same time as bonus levels have also been increased, so the impact on executives’ cash earnings have been mitigated and over the long run considerably enhanced. Not all these plans have made deferred bonus awards yet, so the data may reflect previous practice and next year’s results are likely to be higher.
There are many reasons why deferral is a good idea; it helps retention; it ensures that payment is only made if performance is maintained in the future (if the rules are so written); it can provide malus if future performance declines so providing (some more) alignment with shareholders; and it enables claw-back of bonus in the case of malfeasance (strictly speaking a claw-back clause will allow bonuses that have already been paid to be clawed back from executives. However such clauses will always be open to legal dispute). The benefit of deferral is that is much easier to claw-back that part of bonus that has not already been paid out. In the new 50% taxation regime the deferral of bonus (and other pay) is potentially attractive if the executive thinks that when s/he ultimately receives the pay s/he will be taxed at a lower tax rate.
Recommendations
Remuneration committees should follow four key steps if they are to fulfil their roles and demonstrate value to their shareholders.
Benchmark executive performance
NEDs must look beyond their own boardroom and even sector if they are to benchmark their executive’s remuneration. They must also take account of external factors such as the broader business landscape and identify and isolate factors such as ‘adequate’ performance in a rising market.
One size does not fit all
Adopt a company-specific approach to remuneration and don’t be swayed by immediate competitors as their circumstances may be different.
Don’t boilerplate or template remuneration strategy. Each company is different and has different challenges; take time to identify what ‘good’ looks like before incentivizing executives to deliver it.
Improve transparency to, and communication with shareholders
If companies are using remuneration as a strategic lever this needs to be communicated to shareholders through clear and consistent remuneration reports. These should demonstrate the ways in which steps have been taken to align risk with reward and should clearly demonstrate how performance is incentivized and against which strategic targets. Avoiding “Tin Ear Syndrome” will save embarrassment at the ballot box. Simply following “best practice guidelines” is no longer sustainable.
Remuneration committees must toughen up and scrutinise targets and rewards more fully
NEDs on the Remuneration Committee may need to “up their game”, they may need to be tougher with management when setting pay levels and also when setting the performance targets which determine payouts from incentive and share schemes.
Their role in remuneration is to reflect and protect the interests of the shareholders who will be looking at the remuneration strategies when they re-elect NEDs each year.
How the survey is compiled
Survey Data
The May 2011 survey analyses the latest annual reports of 624 companies. We include most of the companies with financial years ending 31st December 2010, which makes the Manifest MM&K Report the most up to date available.
Total Remuneration Defined
We use Total Remuneration Awarded, as the primary basis of comparison. This is defined as the total of salary, cash bonuses, deferred bonuses, pensions, benefits-in-kind and the expected value of share options and other share plans.
In some places, we use the term Total Remuneration Realised which excludes deferred bonuses awarded in the year and the expected value of share options and other share plan awards in the year, but includes the “amounts realised” from LTIPs and deferred share schemes that vest in the year, plus gains on options exercised in the year. These amounts realised are from awards made in earlier years.
Last Updated: 29 May 2011