Hewitt New Bridge Street says executive reward is key issue for FTSE 250 companies

Executive remuneration is one of the key boardroom issues facing FTSE 250 companies in 2009 – and will impact the ability of companies to weather the economic downturn, according to Hewitt New Bridge Street, the UK’s leading executive remuneration specialists.

Scrutiny of executive reward structures has been mounting over recent months and a Hewitt New Bridge Street study of directors’ remuneration at FTSE 250 companies shows that remuneration committees are facing a tough balancing act – protecting shareholders’ interests while retaining and motivating the vital executive talent that will be needed to navigate companies through stormy economic waters.

Rob Burdett, principal at Hewitt New Bridge Street, which advises over 40% of FTSE 250 companies, said:

“We are now in uncharted territory. As the economy enters recession, remuneration packages are in the spotlight – directors need to be set achievable targets, while investors must be assured that reward levels are not excessive.”

Hewitt New Bridge Street believes that remuneration issue – particularly the way in which key executives are incentivised – will be a critical factor that influences the way UK companies can deal with the economic downturn.

Rob Burdett said:

“FTSE 250 companies constitute a major part of the British economy, and their performance in 2009 will impact the extent of the downturn in the UK. One of the keys to business success in the current environment will be whether companies can successfully agree a reward structure that motivates, incentivises and retains executives in line with overall company objectives.

“However, this is easier said than done as the breadth and depth of the economic downturn remains unknown.

”Other than in some high profile instances, remuneration hasn’t been such a contentious issue for the last couple of years.  This is because a degree of consensus emerged on how executive pay packages should be structured, with the largely benign economic environment also helping.

“However, times have changed, with nearly all our clients now reviewing their remuneration packages, with a few considering making significant changes to reward structures.”

Hewitt New Bridge Street’s 2008/2009 FTSE 250 Directors’ Remuneration report reveals that the median total target remuneration of the highest paid directors was £1.3 million in 2008.

This represents an increase in total reward of between 7% and 10% year-on-year, which is lower than in previous years.

Executive remuneration packages now typically consist of two major elements – fixed and variable pay. Over the past five years, reward packages have become increasingly performance-linked, comprising around 50% variable pay (e.g. annual bonus, long-term incentive plans).

In 2003, variable pay comprised less than 40% of total executive reward. Of the variable pay element, this is typically split between annual bonus (45%) and long-term incentives (55%).

Hewitt New Bridge Street believes that in the current climate the short-term versus long-term split is likely to stimulate much debate.

For some companies, long-term target setting may be very hard, which could provide an argument in favour of increasing bonus potential, albeit with more deferral of bonus into shares. 

This would provide investors with the comfort that long-term performance is being factored in.

However, Hewitt New Bridge Street says that while shareholders are aware of the need for companies to incentivise and retain crucial executives, some investors may need to be persuaded that now is the right time to make major structural changes to the remuneration framework:

“Companies must review their reward structures to ensure the package is both appropriate and effective. However, a knee-jerk reaction is not the solution.

“For some, amending packages within the current framework rather than implementing wholesale structural changes may be the best approach. For example, this might be achieved by setting new targets for future bonus and long-term incentive awards. 

“However, if this year’s bonus targets show low (or even negative) growth compared to last year, executives may have to expect lower payouts than before for hitting their targets. 

“As for long-term incentives, companies that use relative Total Shareholder Return as a basis for performance measurement will probably be able to use the same target as in previous years. More difficult problems will be faced by those companies that use long-term financial targets as these must be set with due account taken of the likely very difficult trading conditions over the next three years. 

“Therefore, these targets may also be lower than before.  Also, now is probably not the time to set over-optimistic targets that could encourage undue risk-taking. For others a more radical approach may be required – such as one-off recovery plans.”

“The trick is to make sure the company’s pay policy – whatever it is – fits its specific situation. Now is not the time for off-the-shelf solutions.”

Hewitt New Bridge Street FTSE 250 Directors’ Remuneration – 2008/2009 summary

Base salary and total remuneration:

The median total target remuneration of all FTSE 250 highest paid directors is around £1.3 million (£1.1m in 2007). The median base salary is £485,000.

The median total target remuneration of finance directors is around £800,000 (£710,000 in 2007) with a median base salary of around £325,000.

For the first time in recent years, the rate of increase in total remuneration for executive directors has fallen to 10% p.a. or less.

Executive base salary inflation is also falling and was around 5%-6% p.a. at the last round of pay reviews. However, for reviews currently being held this has fallen further (perhaps to 0%-3%) due to the current economic conditions.

Packages continue to become more performance-linked. For example, variable pay (i.e. annual bonus and long-term incentives) now accounts for around 50% of a typical FTSE 250 executive director’s remuneration package (compared to 45% in 2007 and less than 40% in 2003), with nearly 55% of variable pay relating to long-term performance.

US CEOs’ total packages are worth about 60% more than their UK counterparts, mainly due to higher levels of variable pay. However, UK finance directors generally receive higher packages than their US peers.

Annual bonus:

The median annual bonus potential remains stable at 100% of salary.

Actual bonuses paid over the period 2001 to 2008 have increased and in 2007/2008 the typical bonus paid was around 80% of the maximum potential. However, given current economic conditions, bonus levels for 2008 are likely to be lower.

Bonus share deferral is now common, with 35% of companies requiring part of the bonus to be deferred in shares for a period of time.

Other elements of reward:

The trend away from options towards Long-Term Incentive Plans (LTIPS) continues. Only 21% of FTSE 250 companies now have a policy of granting options (compared to 50% in 2005).

The most common pension provision is via a Defined Contribution plan (57% of companies). The median contribution for executive directors is 15%-18% of salary.

Only 47% of companies operate a Defined Benefit plan and only 12% of executive directors who joined companies during the last year participate in such a plan.

Non-Executive Directors:

The median non-executive chairman’s fee is £158,000.

Senior independent directors (SIDs) receive fees of around £53,000, non-executives chairing at least one committee £49,000 and non-executives with no chairmanships, £46,000.

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