In September each year Deloitte publishes an annual report on the remuneration of executive directors[1] with an update in April. The latest reports highlight the impact of the recession. Over 70% of FTSE 350 companies implemented a pay freeze for executive directors in 2009 and the data included in the most recent update suggests that around two thirds of companies will continue to freeze salaries during 2010. The average increase in 2009, including those receiving zero, was less than 1% in FTSE 250 and 1.5% in FTSE 100 companies and where increases were given, the median increase was 4%, significantly lower than the 6% to 7% seen over the past few years. Even more unusually, there were also instances of some executives taking a salary cut during 2009.
Chilly times
This is the first time in many years that executive salaries have been frozen. This action indicates remuneration committees, and indeed executives themselves, have responded both to the economic situation, to pressure from investors and various other quarters, concluding that to award salary increases to executives in this difficult climate would be inappropriate.
Unsurprisingly, the recession has also had an impact on the level of bonus paid. For a number of years we have seen around one in five companies increase the potential bonus each year. During 2009 and the early part of 2010, although some companies have increased the bonus potential, this number has fallen significantly. More importantly, for the first time we have seen a number of companies decreasing the potential bonus – 5% of FTSE 100 and 7% of FTSE 250 companies.
Many of the companies with financial periods ending in December 2009 have not yet published their annual reports. Therefore the analysis of bonus payments is based, in some cases, on performance in 2008 which in many companies was still strong. And of course, not all companies have been impacted to the same degree by the recession. To that extent, although the level of actual bonus paid has decreased substantially, the decrease has perhaps been less than might have been expected. The median bonus paid to directors in the most recent financial period was 61% of the potential that could have been paid in FTSE 100 companies and 50% in FTSE 250 companies, compared with 80% in both groups in the previous period. It should also be noted that 15% of directors did not receive a bonus payment at all in the most recent financial period, which has not been common in previous years.
In some companies directors have waived the bonuses due to them. There have also been instances of remuneration committees using discretion to reduce the level of award because the overall performance of the company did not merit the payout generated by the bonus formula. These are actions we have not previously seen to any great extent suggesting that companies are recognising the need to maintain the link between pay and performance in difficult times.
Performance measures
Deloitte’s analysis showed around one in four of companies changed the performance measures on which the annual bonus was based for 2009/10 period.
The wide range of changes demonstrates that companies responded in the context of their own situation. Some companies put more emphasis on balance sheet measures, introducing targets based on cash flow or debt management. For other companies, where setting appropriate financial targets was particularly difficult, additional measures specifically linked to the current business strategy and the long term health of the business were introduced. These included factors such as operational efficiencies, development of new business, and also included some targets very specific to the industry.
The number of companies where the bonus payment depends, at least in part, on specific business objectives of this nature more than doubled between 2008 and 2009 signalling a significant change in the way bonus plans are structured. These kinds of measures are often more qualitative in nature and therefore may demand more judgement on the part of the remuneration committee when determining the level of performance. Companies often require a threshold level of financial performance to be met before these measures are taken into account.
Bonus deferral
Calls for more deferral of bonuses in the financial services industry in response to the concern that short-term bonuses led to excessive and inappropriate risk-taking, appear to have been heeded and across a much wider spectrum than just financial services. The number of companies operating some element of bonus deferral has increased significantly and we expect this to continue. Currently a proportion of the bonus must be deferred in almost three quarters of FTSE 100 and just over half of FTSE 250 companies.
A number of companies are including clawback provisions, although many of these provisions would only be brought into force in exceptional circumstances.
Share plans
Long-term performance continues to be rewarded primarily through performance share plans. Executive directors are now unlikely to be awarded share options, except in the very largest companies where long term awards may consist of a combination of shares and options. The share award typically has a face value of around 1 x salary in FTSE 250 companies and 2 x salary in FTSE 100 companies. The proportion eventually delivered to an individual depends on the performance of the company over a period of time, usually three years.
The typical size of the performance share award has been slowly increasing in larger companies over the past few years. However, investors have indicated that where company performance has been weak they would expect awards made in the following year to be lower. An analysis of the awards made during 2009 and early 2010 suggests that a number of companies responded to these concerns. Awards were higher than the previous year in around 8% of companies but lower in around 14% of companies.
The proportion of the award actually delivered at the end of the performance period tends to be more variable than annual bonuses and generally appears to be better correlated with performance. In FTSE 100 companies the typical proportion of the awards made in 2004 and 2005 vesting in 2007 and 2008 was around 60%. A higher proportion of the 2006 awards vested in 2009, but it should be remembered that for most of the period to which these awards relate, performance was strong in many companies. There is no doubt that many executives are going to feel more pain this year as the awards made in 2007 are tested against targets put in place at a time when performance was expected to be good.
Remuneration committee challenges
As the 2010 AGM season gets underway we are expecting to see more reaction from investors where they believe remuneration policies do not sufficiently support business strategy and potentially reward poor performance. More headlines can be expected. Pressure may start to build from the executives who, in many cases, will have seen substantial cuts in their remuneration over the past year and may expect to see this redressed in 2010 as companies start to emerge from recession. The next twelve months will continue to be an interesting and challenging time for remuneration committees.
[1] Deloitte’s annual executive directors’ remuneration report provides detailed analyses of basic salary, salary increases, annual bonus payments, details of annual and long term incentive design, pension, notice periods and termination payments and other aspects of remuneration policy in FTSE 350 companies. It is based on information from the latest report and accounts of companies in the FTSE 350 as at 30 June 2009, excluding 53 investment trusts and one FTSE 250 company that did not include sufficient information . The data is taken from annual reports and accounts published before this date which includes companies with financial year ends up to and including 28 February 2008. The analysis of long-term plans also includes information from shareholder communication on new plans put forward for approval at AGMs up until early July 2008. A total of 296 companies are included in the analyses.