Special Report

Remuneration Challenges

As the economy hits the most significant downward cycle in 50 years Finance Directors need to take stock of their companies remuneration packages and compensation vehicles. We provide insight and offer advice as we look towards a new era in remuneration. >> Back to Remuneration Challenges special report

Remuneration in the downturn

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Written by Rory Cray, Partner in the Share Plans team at Pinsent Masons   
Friday, 21 November 2008
Many businesses have structures in place which were negotiated two or three years ago and they are not 'paying out' given the downturn.

Businesses wishing to retain their top talent during the economic downturn, will need to be innovative with their remuneration packages.

The pressures that the downturn is putting onto businesses, not to mention the extra scrutiny that executive pay packages are under from investors and the media mean that businesses could find it harder than ever to please all stakeholders.

In current market conditions it is important for companies to consider the principles behind their own remuneration structures, rather than tracking market trends.  

Remuneration arrangements that are designed to encourage performance in areas linked to overall strategy are likely to be well received by investors.  

Many businesses have structures in place at present which were negotiated two or three years ago and these are not now 'paying out' given the downturn in the markets.

Therefore, businesses face a challenge in how to tie-in executives who may be somewhat disgruntled over non-vesting packages.

Salaries remain under close scrutiny from investors: benchmarking (particularly on a market cap basis) is seen as producing a "ratchet effect" that can be difficult to justify.

One response to the economic downturn, and the difficulty of setting longer term targets for incentive plans in the current climate, has been for companies to put more relative weighting into annual bonus where performance measures are based on one year's performance.

In many cases increased annual bonus opportunity is also limited to longer-term tie-ins via deferral of part of bonus into a company's shares.

There are certain pressure points which companies that are looking to rebalance incentive packages, to give more emphasis to annual bonus, need to be aware of:
  • Investors require assurance on the performance measures applied.  This can be best achieved from investors' perspective by a reasonably detailed retrospective disclosure in a following year's remuneration report.
  • Any non-financial measures, for example strategic or personal objectives should be robust and quantifiable and, where possible, disclosed.
  • Companies should consider having an over-riding power to scale back bonus amounts if overall business performance is (in some form) problematic, even if the specific bonus targets have been achieved.  For example, voluntary return of bonus at BA.
One-off retention only bonuses are not favoured by investors as investors are sceptical whether such bonuses will work to retain an individual who may, for example, have been unsuccessful in a promotion process. If an executive really wants to be CEO at a company, the investment community's view is that the executive will be likely to leave and no amount of retention mechanism will be effective in tying the individual in.

Long-term incentives (LTIs) present two particular challenges in the current market:
  • Awards made in past years that are now unlikely to vest; and
  • Setting new performance conditions in current market conditions.

Companies are likely to address the issues around non-vesting LTIs through making new grants.  Amending existing performance conditions will almost certainly not be acceptable to investors.  There was one case in 2008 (HBOS) but investors have subsequently drawn a line in the sand.

In terms of setting performance targets for new LTI grants, remuneration committees have a number of points to consider:

Companies need to consider what LTI grants are intended to achieve: is the LTI to focus on achievement of particular strategic measures in the medium to long-term (in which case financial measures linked to the company's strategy may be appropriate) or are LTIs intended to be a reward if shareholders also benefit (which still points to a TSR based measure)?

Investors expect "stretch" in performance targets, but not at such levels that might encourage unnecessary risk taking.  If targets are relatively lower than in past years, investors may focus on whether grant sizes have likewise been reduced.  Granting on more than one occasion each year may be a way to address some of the impacts of share price on awards (eg TSR measurement start points).

While one-off/transformation type plans are possible, these are likely to be more acceptable to investors if an executive invests his own funds in a plan and if the new plan is linked to the appointment of a new executive team.

There is a case for LTIs at levels beneath the most senior executives having a clear "line of sight" for the individuals (eg based on specific business unit performance rather than group performance).

Service contracts for executive directors remain an area of investor focus although there is an acceptance that these must give both executives and the company adequate protection within the guideline of having a 12 month notice period as a "ceiling".  



 
 
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