The agenda for executive pay committees

Jamin Robertson finds accounting changes, shareholder activism and controversial rewards charting a bumpy executive reward season

Case Study: Barclays

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Autumn marks a complex time for remuneration committees (remcos) as they meet to chart executive-level pay packages. This year’s annual general meeting (AGM) season saw top-level pay once again come under the glare of the media spotlight. Executives accepting glittering rewards for a mediocre performance were bound for a bumpy ride in the national press. Shareholders did not let matters pass lightly, either.

Peter Jauhal, executive remuneration consultant at Hewitt Associates, believes scrutiny has led to increased tension between the pay committee chairperson and the company chief executive. "[Previously] they tended to get on pretty well, but a few colleagues have seen strong disagreements [this year]. Remuneration committees are becoming much more aware of the media, and shareholders. The chairman sees no point in just agreeing with everything the chief executive says, then going to the shareholder meeting and being shouted down. One of my committee chairmen didn’t want to talk to the shareholders at all, and actually asked me to do it."

Institutional investors are certainly flexing their muscles. There have been moves to compel remcos to run any changes past shareholders prior to adoption. There is also increased pressure to abolish retesting, the process where executives unable to meet performance targets in a defined period are given a revised target. Furthermore, shareholders continue to rally against share dilution. And, as if all this were not enough to keep remcos on edge, notice periods remain a priority. Mercer HR Consulting’s European partner, Richard Lamptey, says: "Shareholders are incensed by companies with [executive] notice periods of over a year."

So all in all, it is not a surprise that executive incentive plans continue to attract the close attention of corporate governance watchdog the National Association of Pension Funds (NAPF).

As well as increasingly bolshie shareholder activism, remcos face major incoming pensions changes and redrawn accounting rules. Nicholas Stretch, partner of employment, pensions and incentives at law firm Norton Rose, says: "The burning issue is pensions. It dwarfs what [executives] get by way of bonuses." Certainly, the introduction next April of the £1.5m pensions lifetime allowance (LTA) is big news for remcos, because many senior executives have funds already at that level and, facing a tax hit of 55%, will see little incentive to continue contributing to occupational plans.

Jim Aitken, marketing director at consultancy Chase de Vere, says: "At the moment, companies are looking at restructuring the whole package." While Bhargaw Buddhdev, principal and actuary for executive benefits at Aon Consulting, adds: "[Employers] will be making sure they don’t end up increasing [their spend]. The [simplification] changes [make] things [clearer] for 95% of [workers], but for 5%, the senior execs, it’s not simple."

Clearly remcos will be looking to more tax-efficient alternatives to plunging contributions into an overflowing pensions pot. Options include allowing executives to take early retirement and keep working, or using unapproved arrangements. Or they may choose a cash alternative or set up employee benefit trusts, allowing executives to hold a portfolio of assets. New allowances for self invested personal pension (Sipp) investors to hold residential property will be popular.

And defined benefit pension plan members may even be encouraged to opt out. But whatever the option, in regard to the taxman, it seems execs may run but can’t hide. "There are very few ways you can reward execs now that are wholly tax efficient," says Aitken.

Looking at the overall picture, Mercer’s Executive pay survey 2005 revealed a median executive salary increase of 6% and a bonus level of 39% of salary in 2004, down from 49% in 2003. But it is the Executive directors’ total remuneration survey 2005 by pay consultancy firm Independent Remuneration Solutions (IRS) that proves to be the more revealing read: since 1998 the FTSE has fallen 13%, but the average chief executive salary has climbed 58%, and average total remuneration rocketed by some 208%. In 2004, the median package for chief executives of companies with a turnover above £1bn was £1.7m.

So it is not surprising that industry figures agree that the adoption of performance-based pay is increasing: Lamptey describes the trend as "rippling through all listed companies". Increased performance measures should meet with shareholder approval and fit the UK Combined Code of Corporate Governance that states a significant amount of exec pay should depend on performance.

The Mercer exec pay survey shows bonuses and long-term incentive plans remain popular, although the number of employers operating both share options and long-term incentive plans dropped from 63% to 42% in 2004. That was largely due to the accounting standard IFRS 2, introduced in January, which states the ‘fair value’ of share payments must be expensed in profit and loss accounts.

There is more interest in deferred bonus payments following a 25% take-up rate in 2004, up from 19% in 2003 and 14% in 2002. Norton Rose’s Stretch explains: "It’s sugaring the pill. When a large bonus is a little uncomfortable, this is a different [level of] risk. If the share price drops they don’t get anything like that [amount], and it can be lost if they leave the company." Mercer’s Lamptey also sees a future in co-investment plans and performance share plans. "They’re falling out of love with share options, and moving toward performance shares, but you get these periodic movements in the market, and then it corrects and swings back."

Carl Sjostrom, partner in executive compensation at KPMG (UK), says technical issues are popping up constantly on remcos agendas. This year, he says remcos may need to address the impact of the American Jobs Creation Act for UK companies with US-based staff and fallout from the EU Prospectus Directive. "There are more issues every day for them to get their heads around."

But it seems there’s no need for executives to pitch a realtor’s sign in front of that Belgravia base just yet. "The majority of companies want to pay above the median, and that ratchets up pay. It’s difficult to believe, but sometimes it’s still not enough [for executives]. It’s difficult to believe they can [say that], but they do.

On the agenda this autumn

  • Pensions simplification. In April 2006, pension changes will affect executives with pension pots in excess of £1.5m. Employers are looking to provide executives with alternative arrangements but stress this must be cost-neutral.
  • New accounting rule IFRS 2 introduced on January 1 requires share-based payments to be expensed in company profit and loss accounts, which can affect the organisation’s face-value profitability. As a result, employers may scale back options in favour of performance-based or deferred bonus plans.
  • Employers are moving to increase performance-based criteria for executive employees. This fits with the UK Combined Code of Corporate Governance and satisfies institutional investors.
  • Intense media and shareholder scrutiny make it increasingly difficult to justify high-end bonuses in the event of mediocre company performance. Research indicates a likely increase in pay and bonuses, but at a decreased rate.

Case Study: Barclays

Barclays changed its long-term incentive strategy from a share option plan to a performance share-based system this year, following a review of the reward strategy introduced in 2000.

The new accounting standard IFRS 2 had a limited bearing on the company as it was a relatively minor charge for the bank. In 2004, following a boost in before-tax profits of 20%, chief executive John Varley received a total package of £2,074,000 plus a share incentive package worth £569,000. Chairman Matthew Barrett was group chief executive until 31 August 2004 and received £2,827,000 and shares worth £715,000. Barclays could favour cash allowance payments for high earners after A-day, because the company paid executive director Naguib Kheraj £115,000 last year in lieu of pension contributions.