20/08/2006 11:00

Long-term incentives at many top UK companies are failing to meet the needs of executives or shareholders, forcing some organisations to make constant adjustments to their reward plans, says a report by PricewaterhouseCoopers LLP.

The research, entitled ‘Executive Compensation Review of the Year 2006’, compares how different types of long-term incentive plans align executive pay with returns delivered to shareholders. Traditional compensation models give outstanding reward for outstanding performance but can give rise to anomalies where performance is anything less than stellar. The report shows how two FTSE100 companies delivering similar returns to shareholders over a decade can have an average level of reward that differs by a factor of five, if traditional designs are used (see Notes 1).

Tom Gosling, executive compensation partner at PricewaterhouseCoopers LLP, said:

“Our research shows that commonly used designs are often not hugely successful at aligning executives’ pay with how well they perform for shareholders over a sustained period.

“At the same time, some plans are just too complex meaning that they can be severely undervalued by executives and, in our experience, often discounted altogether. In many cases, they are not effective in encouraging executives to perform better.”

The research shows that a focus on stock ownership rather than performance conditions may provide a more effective system of reward. In many circumstances, a better alignment of reward and shareholder value can be achieved by simply delivering more of an executive’s total pay in company shares and requiring them to hold this stock for a significant period of time (see Notes 2).

Tom Gosling said:

“Companies in the UK, and across the world, are continuing to chase the Holy Grail of better linking pay to performance. A fierce war on talent means that attracting, motivating and retaining the best people is essential to corporate prosperity. Remuneration committees have never been busier coming up with sophisticated compensation schemes to do this.

“Despite all the resources being committed, it remains difficult to get right. Paring down the complexity of reward packages and focusing on stock ownership rather than complex performance conditions, may provide some of the answers.”

The report also found that Britain’s top CEOs saw their salaries rise by an average of 6% last year compared to a high of 14% in 2000.

Use of share options continues to fall with only one third of FTSE100 companies granting options to their CEO, down from over half a year ago. Fifty-three FTSE100 CEOs remain in final salary (defined benefit) pension schemes - an increasing number are in defined contribution schemes.

Incentive opportunities in the top 25 FTSE100 companies are markedly higher. This is largely driven by global benchmarks for compensation with bonus opportunities reaching an average of 175% of salary, compared to around 100% for the remaining FTSE100 companies. Total compensation in the top 25 FTSE100 companies is much closer to US levels.

Bonuses are playing a greater part in total compensation packages for CEOs with average maximum bonus opportunities reaching 120% of salary in the FTSE100 (compared to 45% in 2000) – and an average of over 75% actually paid. Cash bonuses now constitute on average 23% of a total reward package compared to 18% a year ago.

Almost all leaders now get a bonus of some kind. There has been a fall in the number of FTSE CEOs receiving no bonus at all - only 4, compared to 23 in 2000. This is a consequence of changes in bonus design rather than bonus targets getting easier. Bonuses now tend to be offered based on a basket of targets, rather than a ‘hit or miss’ basis. This has also meant that instances of CEOs getting maximum bonus have also become rarer – fewer than 10% in the FTSE100 last year.

Tom Gosling said:

“Bonuses used to be an occasional extra reward for exceptional performance. Now they produce at least some payment in most years, and have become an integral part of an executive’s package meaning a much higher proportion of executive pay is now linked to performance. In many companies, bonus is viewed as a more effective motivator than long-term incentive plans.”

‘Executive Compensation Review of the Year 2006’ also looks at compensation for senior executives and board members, compares executive reward to national average earnings and examines the increasing influence of private equity compensation practices.

ENDS

1. Total shareholder return of 80 FTSE 100 companies mapped against reward, please see attached table.

2. Model of total shareholder return of same companies mapped against reward with stock (restricted for 3 years), and performance conditions removed, please see attached table.

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