CHRONIC INVESTOR BLOG

By Julian Hofmann , 11 May 2012

In these globalised times, the differences in executive pay will be fairly minimal between big multi-national companies in the UK and those overseas, as international comparisons are often used as an excuse to increase existing rewards. However, the emphasis on how performance is rewarded is often remarkably different. So, as part of our contribution to the shareholder spring, we've read the remuneration reports of top British and German companies (it was either that or sit through the Leveson enquiry) to try and find the best way of paying chief executives for performance.

The remuneration models used in Germany or Sweden are often cited as a model for reform. Swedish company policy is directed by binding votes from shareholders, which means that small shareholders tend to turn out in huge numbers when it comes to AGMs - and that tends to put the brake on excessive board pay. However, for the purpose of this exercise, we've placed the emphasis on German companies because the shareholder base tends to reflect the same spectrum of institutional fund managers that populate UK Plc's ownership roll - Germans are traditionally suspicious of owning shares individually.

The surprising fact is that the lot of private German shareholders is, in many ways, worse than their UK counterparts. Not only are the country's biggest companies controlled by cabals of often squabbling family members, but shareholders were only recently given the right to hold advisory votes on executive pay. This peculiarly German situation often descends into unintended satire when it comes to board room appointments. For example, Ursula Piëch's experience as a kindergarten teacher will likely come in handy on Volkswagen's board given the often fractious relationship between the different branches of the controlling Porsche family, as will her connection to boss Wolfgang Piëch, or "Liebling" as she prefers to call him.

But, even if some German companies resemble the court of the Sun King, there is no getting past the fact that the way chief executives are paid in the federal republic is much better tied to the returns they generate for shareholders.

BMW is a good example, and the differences with UK Plc are immediately noticeable in the annual report. To start with, the remuneration report is only 8 pages long for a company with a market cap of more than €42bn (£35bn), while a UK company of similar size, AstraZeneca for instance, requires its shareholders to wade through 15 pages of riveting prose without making it clear why former-chief executive David Brennan earned a bonus almost the equivalent to his salary in 2011, a year of unwelcome share price attrition. By contrast, BMW's position is clear from the first page; executives earn bonuses if net profits exceed €3.1bn, return on sales exceeds 5.5 per cent and dividends come in at between 101 - 110 cents a share.

These are objectively measurable levels of performance and seem to work; the shareholders have seen the shares price rise 25 per cent this year. The link is further strengthened by a rule that requires directors to spend 20 per cent of their bonuses on BMW shares.

Aviva and Allianz

The biggest contrast between the two corporate cultures is between companies in the same industry. Allianz and Aviva have many similarities; both operate in complex fund management and life assurance markets and both sets of directors look like town councillors, although Allianz dwarfs Aviva with a market cap at least ten times bigger. Both are struggling with weak markets and high costs and since the beginning of 2011, their share prices are down by roughly a quarter.

There the similarity ends as the two companies had, until recently, very different notions of how their directors are rewarded. Here's Aviva's executive pay:

And here's the pay at Allianz - as you can see, moving in a very different direction to the pay at Aviva.

The stark difference is down to the fact that bonuses at Allianz are heavily weighted towards the level of operating profits and net income attributable to shareholders. In 2011, neither of these numbers were good - operating profits fell 4.6 per cent to €7.86bn, while net income for shareholders fell 46 per cent to €2.8bn. That triggered automatic cuts in remuneration.

The situation at Aviva is nowhere near as clear cut. It is possible to read the remuneration report two or three times and not be any the wiser as to how bonuses are actually awarded. Pay seems to be linked to return on capital employed, but for a financial company with a fixed amount of regulatory capital, that looks an easy number to hit if costs are kept low. In short, it just doesn't reflect the return that an Aviva shareholder earned at the end of the year, particularly as the dividend has risen by only 2 per cent since 2010.

It's a tangle that new executive chairman John McFarlane must unravel, but most would argue that, as these German examples show, setting executive pay fairly shouldn't really be that complicated.