The yearly survey of the top 10 UK plcs’ CEO total remuneration by Independent Remuneration Solutions (IRS) shows that CEO salaries are up b...

The yearly survey of the top 10 UK plcs’ CEO total remuneration by Independent Remuneration Solutions (IRS) shows that CEO salaries are up by only 3 per cent, but total remuneration has grown by 7 per cent. Cliff Weight of IRS gives a taste of the analysis.

Our 2005 survey of the CEOs of the 10 largest UK plcs shows that average salary increases have moderated to only 3 per cent, but the total remuneration awarded increased by 7 per cent. The analysis is complex. Barclays and Vodafone appointed new CEOs with lower salaries than the previous incumbent. GlaxoSmithKline set their CEO’s pay in US dollars and the 12 per cent decline in the exchange rate reduced his salary in sterling terms. Excluding Barclays, Vodafone and GlaxoSmithKline, salaries went up by an average 11 per cent and total remuneration by 15 per cent.

Back in 2001, CEO pay threatened to run out of control, with Vodafone, GlaxoSmithKline and BP leading the way. However pressure from UK investors has had an effect on these 3 companies, but reduced the performance related elements. Pay at other companies is now catching up and new incentive plans at Shell, AstraZeneca and LloydsTSB will further increase total remuneration.

The survey is unique as it publishes total remuneration. The UK Government’s 2002 Directors Remuneration Report Regulations only require part of remuneration to be shown in the table of emoluments - information on options, share plans and pensions can be put on other pages. The data are not added up and this makes it difficult for shareholders to see how much directors are really paid. Our survey makes pay clear, transparent and readily understandable by shareholders.

Total Remuneration is What the Remuneration Committee Can Control
Each year the remuneration committee has to make decisions regarding salaries, bonuses, pensions, grants of share options and awards of LTIPs. They need to understand and value each of the elements of the pay package and the total expected value of the package. In making remuneration decisions they will consider the potential payments under a range of different performance assumptions. Our survey shows the expected value of the total remuneration and enables shareholders to decide whether the Remuneration Committee has done a good job.

The CEO Cost is Small
The ten CEOs had total remuneration of £59 million ($113.2 million), which sounds a lot. But the increase in value of these companies (from share price growth and dividends) was £49 billion. So the CEO share was only 0.12 per cent.

Private equity would typically offer 5 per cent of the increase in value to the CEO, so they can earn much more for running much smaller companies, and not have their pay made public and open to scrutiny.

Booming Bonuses
Average bonus increased by 28 per cent, to £1.3 million or 129 per cent of salary. The increased emphasis on bonus is a trend in recent years and a number of companies have increased their maximum payments. On top of this more and more companies have bonus matching plans whereby executives can earn further payments in 3 years’ time if certain performance targets are met.

The bonus plans paid out on average at 121 per cent of the target level in a year when their average share price only went up by 4 per cent. Companies need to look carefully at what drives their share price and make sure they reward the right things. These bonus awards look a shade too generous.

Pension
Pension was worth £1.1m for the average CEO, which equates to 118 per cent of salary. By pension we mean the transfer value of the increase in accrued pension in the year.

The average CEO has a pension pot (transfer value of total accrued pension) of £7 million, £3.3 million of shares he owns (they are all male), gains on unexercised options of £1.7 million and vested shares in other plans of £0.8 million. Less than half of this wealth accumulated to date is tied to the performance of the company.

Lord Browne at BP has a pension pot of £15 million. Sir Chris Gent retired from Vodafone with a pension pot of £15 million, which was a £5 million increase on the previous year’s figure. Vodafone have greatly reduced the pension benefit for his successor Arun Sarin who receives a pension contribution fixed at 30 per cent of salary (his 2004 pension benefit was worth only £330,000).

Most CEOs have much more in their pension pot than they have invested in shares of their company and questions have been raised over whether more of the CEO’s wealth should be tied to share price.

Banks
Half the companies within the top ten are of course banks. Barclays made a large long-term incentive award in 2002 to encourage Matt Barrett, then CEO, to stay on. No long-term incentive award was made in 2003 as Mr Barrett prepared to move to the Chairman role. He will of course still have the options and other share incentives, which have been awarded to date. In view of the size of his historic awards, no further incentive awards were needed in 2003 or 2004.

Mr Barrett was highly incentivised when he was hired, principally by large option grants. He also received several large annual grants of options. Only part of these vested as the performance conditions were truly stretching. This is a good example of a well structured incentive package which produced only modest rewards compared to the potential.

The figures for 2004 are for John Varley the new CEO. A large salary increase led to a large pension transfer value in 2004 and a further salary increase announced for 2005 will also generate a concomitantly large pension transfer value in 2005. Mr Varley was awarded a £1.5 million retention share award in 2002 and the new remuneration policy has been developed to incentivise him for the future.

Sir Fred Goodwin at RBS is a star and has the best designed pay package in our view. The successful takeover of NatWest has paid off for shareholders and led to unexercised option gains of £3.5 million, and shares owned of £1.1 million. These together with regular grants of options and LTIPS created a long term focus and rewards for long term success. However recent salary increases in the past three years of 14 per cent, 18 per cent and 10 per cent have fed through into pension values, which of course are not performance linked.

At LloydsTSB Eric Daniels became CEO in 2003 and his total remuneration awarded was £2.1 million, which was significantly less than the other banks. The data for 2002 and prior years are for the previous CEO Peter Ellwood. It is noticeable that much of Mr Ellwood’s remuneration came in the form of pension, during a spell of relative underperformance against other banks.

LloydsTSB are unusual in having a share option plan with unusually tough performance conditions. Lacklustre performance has meant that most options grants have not paid out or are unlikely to do so. The threshold for options to vest is 8th rank of 15 comparators of TSR after 3 years.

In 2003 Lloyds changed their main remuneration consultants from Hay to Towers Perrin and announced a large salary increase for the CEO to £750,000 and asked shareholders to approve new, more complex and more lucrative plans at the 2004 AGM.

Even though the options are in the money, in the graph below we have valued the options at zero because of the performance conditions. Mr Varley was awarded a share retention award of £1.5 million in 2002, which is now worth less than this due to the decline in the Lloyds share price.

An Example For Others to Follow?
The 10 largest companies have a combined market capitalisation of £675 billion. They form over half of the FTSE 100 by value. They are the bellwether of UK best practice - what they do sets the example for others to follow.

Other key findings:

- Total remuneration awarded in 2003 ranged from £3 million to over £9 million.

- The average increase in total remuneration awarded was 7 per cent, but the range was from plus 85 per cent to minus 26 per cent.

- The average increase in the transfer value of accrued pension was £1.1 million, which was 118 per cent of the average salary.

- Salary was only 16 per cent of the total remuneration awarded. Pension was 19 per cent.

- Companies say they link the majority of pay to performance. However this has not happened in practice. CEOs pensions are worth much more than their shares and options. (This has happened because CEOs were allowed to sell their shares acquired from share plans and diversify their risks, which reduced their alignment with shareholders.)

- The average total remuneration awarded by leading companies is 2.5 times the total emoluments disclosed.

The total emoluments figure shown in annual reports is the sum of salary, taxable benefits, and bonuses. We calculate the Total Remuneration Awarded, which is the total emoluments plus the “fair value” of share options, LTIPs and other long term incentives, plus the value of pension. The fair value of share options, LTIPS and other long term incentives is our estimate of the value, taking account of any performance conditions and a range of performance scenarios. The value of the pension benefit is the increase in the transfer value of accrued pension, net of any employee contributions.