Executive incentives failing to boost performance

Aug 22 2006 by Nic Paton Print This Article

Despite approaching U.S levels, the incentives offered to many top British executives are sometimes so complex they fail to encourage them to perform better at all.

A new study by accountancy firm PricewaterhouseCoopers LLP looked at how different types of long-term incentive plans align executive pay with returns delivered to shareholders.

The research also found that salary levels last year for Britain's top executives rose by just 6 per cent last year, compared with 14 per cent in 2000.

Nevertheless, total compensation packages in the top 25 FTSE-100 companies were now much closer to U.S levels, it found.

The research argued that many organisations are forced to make constant adjustments to their reward plans simply to ensure they are keeping both shareholders, and their executive talent, happy.

Traditionally, compensation models are designed to give executives outstanding rewards for outstanding performance.

But, as said PWC, this could also give rise to anomalies "where performance is anything less than stellar".

Two FTSE-100 companies delivering similar returns to shareholders over a decade could have an average level of reward that differed by as much as a factor of five if traditional designs were used, it calculated.

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

"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," he pointed out.

The research suggested that a focus on stock ownership rather than performance conditions could provide a more effective system of reward.

In many circumstances, a better alignment of reward and shareholder value could be achieved simply by delivering more of an executive's total pay in company shares and requiring them to hold this stock for a significant period of time.

Gosling added: "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," he continued.

"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," he concluded.

Generally, the use of share options as an incentive has continued to fall, with only one third of FTSE-100 companies granting options to their chief executive, down from more than half a year ago, said PWC.

Fifty-three FTSE-100 CEOs remained in final salary pension schemes, and an increasing number are in defined contribution schemes, it added.

Incentive opportunities in the top 25 FTSE-100 companies were markedly higher, it pointed out.

This was largely driven by global benchmarks for compensation with bonus opportunities reaching an average of 175 per cent of salary, compared with around 100 per cent for the remaining FTSE-100 companies.

Bonuses are playing a greater part in total compensation packages for chief executives, the survey suggested, with average maximum bonus opportunities reaching 120 per cent of salary in the FTSE-100, compared with 45 per cent in 2000.

An average of more than 75 per cent of this was actually paid, with cash bonuses now constituting on average of 23 per cent of the total reward package, compared with 18 per cent.

Almost all leaders also now got a bonus of some kind. Just four FTSE CEOs last year got no bonus at all last year, compared with 23 in 2000.

This, argued PWC, was a consequence of changes in bonus design rather than bonus targets getting easier.

Bonuses now tended to be offered based on a basket of targets, rather than a "hit or miss" basis.

This had also meant that instances of CEOs getting maximum bonus had also become rarer fewer than 10 per cent in the FTSE-100 last year.

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."

The PWC report has come as a separate survey by the GMB union has calculated that directors and chief executives of major organisations, perhaps unsurprisingly, top the UK salary league.

The two positions reported average earnings of 171,509 in 2005, an increase of 9,481 on 2004, said the GMB.

But at the other end of the salary league were leisure and theme park attendants with average earnings of just 10,420, it pointed out, a drop of 1,272 on 2004.