Deloitte, the business advisory firm, today outlines the emerging trends in the pay of UK executive directors in its annual report, Executive Directors’ Remuneration, the key findings of which show a rise in bonus levels, and a greater emphasis on performance-based reward.
Salary increases are slowing, with the median basic salary increase for executive directors in the FTSE 350 being 6.5 percent compared to 7.1 percent in 2004 and 7.5 percent in 2003. Although executive salaries continue to increase faster than for all employees (average earnings increased by 4.4 percent in 2004), of more significance is the increase in the opportunity to earn more for performance. The typical maximum annual bonus award is now 100 percent of salary in both FTSE 100 and FTSE 250 companies. Within the 30 largest UK companies the maximum potential bonus has increased from 125 percent to 150 percent of salary. For achieving on target performance, 50 percent of the potential bonus is earned.
Carol Arrowsmith, head of the remuneration team at Deloitte, comments: “The rise in bonus levels has been accompanied by an increase in the introduction of a deferred element in these plans. Deferred annual incentive plans are now in place in 61 percent of FTSE 100 companies and 44 percent of FTSE 250 companies, compared to 56 percent and 34 percent two years ago”.
Deferral arrangements vary greatly, but typically they require some of the annual bonus to be paid in shares which must then be retained for several years, working as a ‘lock in’. There may also be the opportunity to receive additional ‘matching’ shares if further performance criteria have been achieved during the deferral period.
The number of share option plans being introduced and in operation is decreasing, with performance share plans being used in their place. Share options are regularly granted to executive directors in 52 percent of FTSE 100 companies and 48 percent of FTSE 250 companies compared to 85 percent and 76 percent respectively two years ago. Performance share plans are now operated by 82 percent of FTSE 100 companies and 62 percent of FTSE 250 companies compared to 64 percent and 43 percent respectively two years ago.
“One reason for this trend is the requirement for companies to count the cost of options towards profits . Also, many companies feel that performance shares provide a clearer link between pay and performance. However, it is still too early to predict the end of share options,” comments Arrowsmith.
The value of executive pensions is significant and this is expected to lead to increasing attention from institutions, who will be seeking an explanation and justification for generous pension arrangements. Basic salary and pension increase with company size as the table attached shows.
We expect pressure from the shareholders and institutional investors to have an impact. Our 2005 report demonstrates two areas where such pressure has resulted in significant change. Only 2 percent of executive directors in FTSE 100 and 3 percent in FTSE 250 companies now have a notice period in excess of 12 months compared to 16 percent and 11 percent two years ago. This dramatic decrease has followed pressure from shareholders and governance bodies over the past 24 months to eradicate the possibility of rewarding executives when the business has failed.
The provision in share option plans that allow executives ‘two bites at the cherry’ i.e. where performance conditions can be measured more than once if they are not met at the end of the performance period, are also becoming less common, with a marked decrease in their prevalence in the past two years. Currently, 77 percent of FTSE 100 and 73 percent of FTSE 250 companies do not allow any re-testing of performance conditions compared with 33 percent and 45 percent last year.
“Over the next twelve months we can anticipate that governance bodies will focus on three key areas. Shareholders want to see evidence that companies are using robust and sensible methodologies to set pay. They will also want to see further alignment of the performance measures used in share incentive plans and the requirements and strategic objectives of the business. Finally, there will be increased scrutiny on pension arrangements and in particular on defined benefits arrangements with regards to their size and appropriateness,” concludes Arrowsmith.