Financial sector replacing bonuses with increased pay and long-term incentives

Base pay increases, a greater use of deferred compensation and long-term incentives are replacing short-term incentives in the financial sector..

According to Mercer’s annual Pan-European Financial Services Executive Remuneration Survey, which provides base pay and bonus data for senior executive level positions, decreasing annual variable compensation levels have been balanced with the introduction of deferrals, turning the bonus system into a more effective means of aligning bonus payouts with the time horizon of risks.

Median salary increases during 2009 to 2010 across all senior roles in the financial services sector was around 2%. However, roles with responsibility for internal control in the financial sector received notably higher pay increases with chief risk officers receiving 5%. A majority (73%) of organisations stated they would be increasing the salaries of employees in these positions, however, only around 50% believed salary increases would take place for other roles.

Compared to 2008, the proportion of base salary and long-term incentives in an employee’s overall 2010 compensation increased, while annual bonuses decreased. This is in direct response to regulator pressure.

In 2008, executive positions would have received 25% of their compensation as base pay and 40% in short-term incentives, with the final 35% in the form of long-term incentives such as equity plans.

The picture changed dramatically in 2009, with 60% of the same executives receiving no annual bonus. So the real trend is only evident in the 2010 figures. According to this data, in 2010, the same executive positions received 34% of their compensation in base pay, 30% in short-term incentives and 36% in long-term incentives.

For chief executive (CEO) positions, this shift in pay mix is particularly evident where the long-term incentive proportion of their pay mix shifted from 36% in 2008 to 46% in 2010, and the weight of CEO’s annual bonuses dropped substantially from 39% in 2008 to 23% in 2010.

The report also found an increasing number of organisations are deferring part of their variable compensation – from 45% of firms in 2009 to 67% in 2010.

The average period for a deferred bonus is now three years with the mandatory minimum, according to regulatory requirements the majority of organisations have a deferral setup with a clawback structure, which allows an organisation to take back previous performance-based payments on the basis of restated financials or breached agreement.

Around two-thirds of companies have introduced or are considering introducing a malus-type bonus arrangement in which a major portion of the employee’s bonus is not immediately available and can be reduced if there are losses or if business indicators fall substantially during the multi-year deferral period.

In 2011, the vast majority of organisations will increase salaries, with an average rise of 2.5% as part of their normal annual salary review. In the past two years, almost all financial services organisations have made changes to their compensation programmes and performance measures. Most commonly, they have introduced a mandatory deferral plan.

Moving forward, organisations expect to tailor their deferral plans to new regulatory requirements. A third respondents plan to adjust or introduce clawback arrangements with malus bonus in 2011. While 30% of organisations forecast higher 2011 bonus pools compared to the previous year, 60% expect no change.

Vicki Elliott, the partner leading Mercer’s rewards consulting in the financial services industry, said: “Executive compensation and remuneration committees have endured another year of strong focus and scrutiny by its stakeholders.

“Our data shows corporate governance processes have been strengthened and pay structures have evolved since 2008. The widespread salary freezes and salary cuts for executives have come to an end and most organisations have gone back to regular salary reviews.”

Read more articles on remuneration in the financial services sector