Is it time for the tide to turn on executive pay?


16-09-2011

Is it time for the tide to turn on executive pay? Deloitte publishes insights from its 2011 Executive Directors’ Remuneration report.

  • Executive pay structures have seen positive change with an increase in deferral, clawback and share ownership guidelines
  • However, after two years of pay freezes, pay increases for executive directors have restarted at a slightly higher level than for average employees
  • More focus is needed by Remuneration Committees to justify the link between annual bonus payouts and performance delivered to shareholders
  • Companies delivering strongest returns to shareholders tend to have a more consistent and longer serving senior team holding significant numbers of shares.

    While FTSE 350 companies have taken positive steps to improve their executive remuneration structures, there is still more work to be done by many to achieve best practice and ensure that reward is linked to performance, according to the latest Executive Directors’ Remuneration report from Deloitte, the business advisory firm

    Juliet Halfhead, director in the remuneration team at Deloitte in Cambridge, comments: “While there have been positive changes, such as the trend towards more deferral and retention of shares and the increase in clawback provisions, we are also seeing above target annual bonuses payouts on a regular basis.

    “Remuneration committees need to remain vigilant and ensure that remuneration is fair and reasonable from a participant’s and shareholder’s perspective. Reward should be linked effectively to the long-term strategy and success of the company. Our research has identified a number of key areas that companies must address, and some common traits in the companies delivering the strongest returns to shareholders.”

    Companies should ensure base salary increases for executives are limited to those of the general population. If director salaries are currently above market median then the remuneration committees should consider implementing a pay freeze in order to exhibit restraint in these difficult times, says the business advisory firm.

    “In addition to limiting salaries, remuneration committees should acknowledge that paying target bonus requires genuinely good performance, when setting the annual bonus targets. For bonuses in excess of this amount, truly stretching performance should have been achieved. During the design of long-term incentive plans, performance conditions should be aligned with the strategic vision of the company and shares should be held for long enough to align the interests of shareholders and management.”

    The Deloitte research identifies two characteristics commonly shared by companies delivering the strongest returns to shareholders: they tend to have a more consistent and longer serving senior team than the general market; and these teams typically have much larger shareholdings.

    Salary rises
    After a period of two years when many FTSE 350 companies awarded no salary increases to executive directors, most are seeing their salaries rise in 2011. Increases for main board directors in FTSE 100 companies in 2011 are typically between 2.5% to 7.5%, with a median of 4%, and between 0.5% to 5% in FTSE 250 companies, with a median of 3%.

    Halfhead comments: “It is not surprising that after a two year period of widespread pay freezes there has been a return to pay increases for executive directors. What has surprised us is the number of salary increases above 5%, which is significantly above inflation and the increase in average employee earnings. Remuneration committees should consider increasing salaries only where there is a real and compelling reason to do so and any increases should be limited to the general level of increase for other employees, unless exceptional circumstances exist.”

    Annual bonuses
    The maximum annual bonus opportunity for FTSE 100 or FTSE 250 executive directors has remained constant at 150% and 100% of salary, respectively. However, bonus payouts have increased during the year from 71% of maximum to 87% of maximum for FTSE 100 companies and from 54% of maximum to 86% of maximum for FTSE 250 companies. Over the past ten years, across all companies, median bonus payouts have consistently been around 70% to 80% of the maximum.

    Halfhead says: “Annual bonus plans are an area where some hard thinking should be done. There is a very strong argument for a recalibration of both targets and expectations to ensure that these payouts do not, in effect, become almost guaranteed.

    “A positive development is that over two thirds of FTSE 100 companies and half of FTSE 250 companies now defer part or all the bonus and around half of these companies have also introduced clawback provisions. This is an encouraging trend. It is clearly good practice to ensure there are provisions allowing for deferred or unvested awards to lapse in the event of gross misconduct, misstatement of results, or where there has been a miscalculation of the extent to which performance conditions were met. In companies where there is less certainty that a year of good performance will translate into longer-term sustainable performance, it may also be appropriate to consider having more rigorous clawback provisions in place. This is an example of lessons being learned from the financial services sector and applied to the broader market.”

    Long-term incentives
    Long-term incentive opportunity for FTSE 100 companies has remained constant during the year with a slight uptick in the FTSE 250. However, typical payout levels as a proportion of the maximum are lower than those of annual bonus plans and there is no payout from these plans in at least a quarter of companies in most years.

    Halfhead comments: “Long-term plans tend to be strongly linked to performance and can effectively support the business strategy and deliver shareholder value.

    ”Even in the best designed incentive plans it is important the final payouts under both annual and long-term plans are determined in the context of overall company performance, the current environment and all other relevant factors. Remuneration committees should be more prepared to use judgement when making these decisions, both positive and negative.”

    Shareholdings
    Over the past decade, there has been a large increase in the number of companies with deferred bonus plans and with shareholding requirements in place for senior executives. Some long-term plans are now incorporating further retention periods, but required shareholdings are typically limited to one or two times salary. Shareholdings in the top performing companies are typically much higher than these requirements and the actual shareholdings of most executives, with a median of 11 times salary for the CEO in the top performing FTSE 100 companies and a median of three times salary for the CEO in the top performing FTSE 250 companies.

    Halfhead comments: “Another positive trend is the increase in the number of companies where part of the bonus is paid in deferred shares and further retention periods have been introduced following the vesting of share awards. We would encourage companies to continue their emphasis on shareholding requirements as there is a clear alignment with other shareholders.”

    Halfhead concludes: “The Government is about to release new proposals on remuneration disclosure and we expect it to send a clear message to UK businesses that other ways of controlling remuneration have not been ruled out.”
     

 

The Deloitte Cambridge office comprises 8 Partners and over 250 staff who deliver a full range of professional services to the East Anglian region. As well as focussing on the life sciences and technology sectors for which the region has become so renowned, the office has long standing specialisms in other sectors including the professions, consumer business, food and agribusiness.

Deloitte LLP