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Director Renumeration Trends in the FTSE 250

David Tuch

Deloite & Touche LLP

30 November -0001

This is the second in a series of articles focusing on trends in the remuneration of directors of companies in the FTSE 250 (excluding investment trusts). Information is taken from annual reports accounts published before 30 June 2005 and, in the case of long-term incentive plans also includes information from shareholder communications on new plans put forward for approval at AGMs up until early July 2005.

Last month the first of this series of articles focusing on directors remunerationin FTSE 250 companies considered the remuneration environment which has existed over the last year and then provided a high level summary of the recent trends.

In this article we have focused in more detail on annual incentive plans. In subsequent articles we will focus in more detail on deferred bonus plans, long-term incentive arrangements and on non-executive directors’ remuneration.

Annual incentives

All but four FTSE 250 companies have an annual incentive plan in place in which executive directors are eligible to participate.

There is no requirement under the Directors’ Remuneration Report Regulations to disclose the details of annual incentive plans but best practice guidelines such as those produced by the ABI and NAPF make it clear that investors would prefer to see an upper limit in place and that this should be disclosed. The majority of companies now disclose the maximum that can be earned under these plans and uncapped plans appear to be decreasing. In many cases the performance measures on which the plan is based is also disclosed.

Only 4 per cent of FTSE 250 companies do not disclose the maximum and a further 11 per cent appear to have no limit, compared to 12 per cent last year.

Target and maximum awards

In FTSE 250 companies target award levels have not changed significantly this year but the maximum that may be earned has increased significantly. For the first time since we have been analysing the data, the median maximum award is the same in FTSE 250 companies as it is in FTSE 100 companies, at 100 per cent of salary.

Over the past year 35 FTSE 250 companies increased the maximum award that could be earned, compared to 37 over the previous period. In some cases the additional amount of bonus may be awarded in deferred shares.

The following table indicates the quartile range of on-target and maximum awards that may be earned, shown as a percentage of basic salary. The percentages relating to target awards are based on a smaller sample of companies providing this information.

It is important to note that the percentages given in the above table include any deferred element although we have excluded any matching shares that may be awarded based on continued employment or performance over the deferred period. To that extent the numbers overstate the potential cash bonus that may be paid.

The upper quartile, median and lower quartile maximum cash bonus that can be paid is 100 per cent, 70 per cent and 50 per cent respectively. Where a participant is invited to invest part, or all, of the award, usually with the opportunity to receive further matching shares at the end of the deferred period, the total bonus has been included as cash.

The chart below shows how the potential awards that may be made to main board directors under annual incentive plans have been steadily increasing over the past few years.

Annual incentive plans – maximum awards 2001/2002, 2002/2003, 2003/2004 and 2004/2005

There continues to be a significant number of companies where the potential award is higher for the top full time executive than for other main board positions. In FTSE 250 companies 16 per cent of plans have a higher maximum for the top position compared to 18 per cent last year. In some cases the finance director may also be included in the higher bracket.

Where there is a higher potential for the top full time executive the bonus is likely to be 30 to 40 per cent higher than for other main board directors.

Actual award levels in the last financial year

The table below shows the range of actual bonus awards made in the last financial year as a percentage of basic salary to all executive directors, excluding the top full time position, and the range of target bonuses in place.

The following tables show the range of bonus awards for the top full time executive and all other executive directors.

Top full time executives

Bonus as % of basic salary by market capitalisation

All other executive directors

Bonus as % of basic salary by market capitalisation

In the above tables the actual bonuses paid to executives in the past year are shown as a percentage of basic salary. Since each company may have a different bonus potential, these tables do not provide any indication of how close the actual payments are to the maximum that may be earned. This relationship is examined in the table below.

For each company we have taken the average incentive award paid to all main board directors in the past year and calculated this as a proportion of the maximum that may be earned in that company.

The table shows that the number of companies where no payments were made under the annual incentive plan continues to decrease in FTSE 250 companies.

Annual bonus – average awards as % of plan maximum

Performance measures

There has been no significant change in the performance measures on which annual incentive payments are based. The number of plans based on profit (typically group profit for the chief executive, finance director and other group positions, but may include an element of divisional profit for the heads of subsidiaries and divisions) has increased slightly and is still by far the most common measure. However there has also been a slight increase in some of the other measures used.

Annual bonus plans – performance measures

Pensionability of annual incentive payments

There are very few companies where the bonus payment is pensionable and where this is the case, the bonus payment is usually only pensionable in part, or the practice only applies to existing directors, with new appointments on different terms. In addition to this there are some companies where the bonus is pensionable for US directors which is in line with market practice in the US.

Overall, in 5 per cent of FTSE 250 companies, at least part of the annual bonus is pensionable for at least some of the directors.

Conclusion

We believe that companies will come under increasing pressure to disclose more information than in the past concerning the extent to which performance conditions have been satisfied and remuneration committees may face challenges where they use discretion to award bonuses which do not appear to be unjustified by the results. In addition, the shareholders will continue their increased focus on annual incentive plans challenging arrangements which do not appear to them to adequately link pay to performance.

Ensuring that annual incentive plans are properly structured will therefore continue to be high on remuneration committees’ agendas. The next article in this series will focus on deferred bonus plans which are now operated by 44 per cent of FTSE 250 companies and therefore are increasingly a key part of the remuneration package of directors of FTSE 250 companies.