The People Bulletin

Many executive remuneration models are not meeting their objectives either of motivating executives or aligning them with shareholders.  And many associated with executive remuneration – shareholders, remuneration committees, executives themselves, not to mention the wider public – appear to be dissatisfied.  

While action is underway to transform the governance and design of reward, making fundamental changes is difficult, since in many cases the level of trust between companies and their shareholders in the area of remuneration is low.  As such, the current interactions between shareholders, remuneration committees and executives regarding plan designs and performance conditions are leaving all parties frustrated.  We need to break the mould of traditional thinking in this area and move to a new model if we want executive pay to work more effectively. 

This means using simpler plans, with a greater role for remuneration committee discretion in making a rounded assessment of performance.  Ensuring executives are significant shareholders will often be more successful in achieving alignment than complex long-term incentive plans.

Response to the recession

Encouragingly, PwC’s annual report of FTSE remuneration, Executive Compensation - Review of the Year 2009[1], shows that FTSE 100 companies have exercised pay moderation in response to the recession.  For example, median increases in base salary for FTSE 100 and FTSE 250 executives fell to 1% and 0%, respectively, in 2009 and were outstripped by the national average earnings base pay increase (2.5%) for the first time in a decade.  In 2008, increases were 6% for both the FTSE 100 and FTSE 250 while the national earnings pay increase was also higher at 3.7%.      

The research also found that median maximum bonus potential for CEOs remained stable at 150% of salary in the FTSE 100, equivalent to around £1.2m, and 100% in the FTSE 250, which would equate to around £425,000 if paid out in full.  But, actual bonus payments decreased by 20% in 2009 reflecting business performance and the economic climate.  The median bonus payout for CEOs in the FTSE 100 and FTSE 250, respectively, were £525,000 and £217,000.  One in six executive directors in the FTSE 100 and FTSE 250 did not receive a bonus in 2009. 

Median total long-term incentive grants values fell slightly at CEO level with the median economic value of awards now at 140% of salary – roughly equivalent to just over £1m.  Companies experiencing significant falls in share price have scaled back award levels by anything between 20% and 40% in response to shareholder pressure.  The most common plans remain performance share plans, deferred bonus plans and share options. 

Challenges facing remuneration committees

Notwithstanding this moderation, shareholder opposition to remuneration proposals grew, with 20% of FTSE 100 companies have more than one in five of their shareholders withhold support for the remuneration report, up from 3% in 2008.  The majority of contentious AGMs arose outside the banking sector.

A key challenge for remuneration committees is to balance the need to motivate executives in the face of a shifting business environment, reduced bonuses and increased taxation against shareholders’ perceptions that the link between pay and performance is not strong enough, and that one year of pay restraint is not sufficient given the severity of the downturn and the impact on profits[2]. 

With the next AGM season taking place during or in the run up to an election, against a backdrop of continued economic uncertainty, scrutiny on executive pay arrangements will not diminish this year.

The perceived issues with pay are not as great in other sectors as in the banking sector, but there are lessons to be learned. While deferral of bonuses is already common in quoted companies, issues such as allowance for risk in assessments of performance are not adequately addressed in many companies.  With the Combined Code[3] and ABI guidelines[4] now making clear the responsibility of remuneration committees to factor risk into performance assessments, we see this as a significant area of focus for the coming year.

Our nine-point proposal for change

• Change is coming and trust needs to be rebuilt. There is tangible public anger around remuneration, which impacts every organisation’s ability to do business. To bring about change requires an improvement in trust, between remuneration committees, shareholders and executives. Companies need to improve consultation with shareholders, which will lead to greater support for the judgement of remuneration committees and greater trust in executives to act responsibly.
  
  
  
• A new executive reward model is needed. Organisations need to tailor their remuneration models to their business strategy, moving away from a follow-my-leader mentality. Simplification is key to success. Often this will involve fewer complex incentives and a greater focus on long-term stock ownership to achieve alignment.
  
  
  
• Pay for performance must become a reality for all. Shareholders need comfort that pay for performance is real. This means an end to pay for effort and a clear articulation of what constitutes performance. Skill and luck must be separately identifiable.
  
  
  
• The upward ratchet in executive pay should cease. Executive pay must reflect the nature of supply as well as the demand for talent. For average performers this will mean that pay will come down, but for the best it will continue to grow, as individuals are differentiated based on the value they add to the enterprise.
  
  
  
• The reward package should be considered in its totality. Salary and incentives are not the only components of an executive’s pay. Other aspects of pay cannot be ignored and the difficulty in assessing the competitiveness of the total reward package must be overcome.
  
  
  
• Remuneration committees must stop over relying on data. Following the market has contributed to the problems that are now being faced. In times of major change, the measurement and use of historic remuneration data has limited relevance.
  
  
  
• Governance must have substance as well as form. Being a remuneration committee member is, and should be, a tough job. There is a need for committees to be more challenging, to exercise more discretion while managing the board to avoid divisiveness over pay. Robust governance processes must be in operation throughout the organisation with clear oversight of responsibilities.
  
  
  
• Advisers need to up their game. In the future, there needs to be less focus on the supply of market data and greater focus on advisers providing high-quality, robust challenge, strategic input and analysis. Conflicts of interest must be managed to ensure that the remuneration committee has access to independent advice, without introducing unproductive conflict into the relationship with management.

• The case for executive pay needs to be made. Pay is part of the equation that can assist in supporting skilled executives to perform to the best of their abilities. High potential pay for performance, responsibly governed, is a force for good. This needs to be remembered, emphasised and communicated.

Achieving change is proving an immense task for all involved, particularly remuneration committees.  But we all need to rise to the challenge.  If we do not, then there is a risk that we will lose the freedom to use pay as a force for good, motivating executives by rewarding success.

http://www.pwc.com/gx/en/hr-management-services/index.jhtml

[1] http://www.ukmediacentre.pwc.com/Media-Library/Executive-Compensation-Review-of-the-Year-2009-65d.aspx

[2] See also Rupert Merson’s article ‘Bonuses – nudge, nudge, wink, wink’ in The People Bulletin, 17 December 2009

[3] http://www.frc.org.uk/corporate/combinedcode.cfm

[4] http://www.abi.org.uk/