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So richly rewarded

Created:
2 July 2008
Written by:
Alistair Blair

Last week's column (Where are the bankers' bodies) provoked several emails which unanimously agreed with my argument that bank leaders who had so recently been pursuing share buyback programmes at high prices, only now to be proposing the reissue of those same shares at low prices, should have been removed from their posts. In any other area of employment, it would be taken for granted that the supply of huge funds by owners to rectify a huge mistake by managers would also involve installing a replacement management team.

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Especially when the old guys have been so richly rewarded. In 2005, when HBOS began the share buyback programme now so bitterly regretted, it paid its executive directors £2.2m of annual bonuses on top of their £3.6m of base salary. In 2006, as it poured another £1bn into buybacks at an average of £10 per share, the bonus payout was 100 per cent of salary, making £6.6m in all.

Incredibly, earlier this year, as HBOS must already have been drafting out the rights issue it could no longer avoid, the bank's remuneration committee waved through a further £3.3m in annual bonuses for executive directors. But that wasn't the end of it. A couple of years ago, HBOS dreamed up a further scheme to reward directors.

This is called the "biennial cash incentive" to distinguish it from the merely annual incentive. This new scheme was meant to reward "sustained achievement of group operating objectives". Sustained? Sustained across the business cycle, perhaps? Ha ha. In the land of director remuneration, the principal appears to be to extract money under any conceivable heading.

You might have thought that if a two year scheme was introduced in addition to a one year scheme, the one year scheme would have been knocked back a bit. Does it make sense to award a bonus for 2006, a further bonus for 2007, and then a further bonus for 2006 and 2007 combined?

Not a bit of it

For 2005 - the last year before the biennial scheme came on stream - HBOS directors were in for a target annual incentive of 75 per cent of basic salary. As of 2006, their annual incentive target payout stayed at 75 per cent of salary, and under the biennial scheme they additionally stood to gain 11 per cent of salary for 2006, 11 per cent for 2007 (in addition to the annual incentive for 2007) and a further 15 per cent of salary for the two years combined. That added a whopping 37 per cent to HBOS' target payouts to its directors.

If your head, like mine, is reeling from trying to take this in, just consider the outcome. For the year ending December 2007, the biennial scheme paid out £1.1m. taking total short term bonuses for executive directors last year to £4.4m, on top of basic salaries of £3.8m. This at the bank which, having paid £2.5bn for its own shares during the same period at around 950p per share, is now reissuing those same shares at 275p per share.

To add insult to injury, HBOS' annual report records that for the current year, the target payout under the annual scheme has been lifted to 90 per cent of basic salary and the biennial scheme's target payout is 22.5 per cent for 2008 and a further 22.5 per cent for 2009. Moreover, the targets under the biennial scheme for the previous year are being retrospectively adjusted upwards "to better ensure that we can recruit and retain the calibre of colleague we require – and engage and motivate them to deliver our stretching operational targets – during the current volatile financial climate".

Hollow words. They suggest that when the climate calms down, these target payouts will be reduced. The chances of that happening, I'll leave you to ponder for yourself.

It is of little comfort that HBOS' directors have taken the greater part of these annual and biennial bonuses in shares. Those individual director shareholdings are now being rescued at the expense of the rest of HBOS' shareholders, who are having to inject £4bn in the current rights issue to ensure the bank maintains a sound balance sheet.

This little case study, the essential elements of which are duplicated at all the big banks and indeed across the UK's largest companies generally, demonstrate that the rapid increase in short term incentive payouts to directors is a beast on the rampage. At this level in the organisation, incentives should reflect the permanent accretion of wealth to shareholders, not the short term blips. Payouts on this scale for annual or even biennial performance are a nonsense.

MORE FROM ALISTAIR BLAIR...

Read more of Alistair's columns at his IC home page.

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Alistair Blair is a past winner of the Business Writer of the Year Award, and has worked in investment banking and fund management.

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