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OPINION

Every little helps some more than others

Every little helps some more than others
November 12, 2014
Every little helps some more than others

There's a view now that Tesco's (TSCO) strategy was over ambitious and Sir Terry quit while the going was good. Any successor was being set up to fail. That's as may be, but it's of little consolation to shareholders who placed their faith - and their investments - in the new management team. But if the strategy and delivery, let alone the accounting, were in some way distorted, so in one respect was the pay.

Sir Terry's salary had been £1,432,000; when he replaced him, Philip Clarke's was increased from £825,000 to £1,100,000. By the time he left, it had drifted up to £1,145,000. Dave Lewis is starting on £1,250,000. The question is: does it make sense to compare salaries in isolation like this?

When Sir Terry left, the Remuneration Committee streamlined Tesco's performance related pay. They're now reviewing it again. For Philip Clarke, this turned out to be academic. He elected not to take a bonus in his first year, and after that the performance conditions failed - so all he received as CEO was his fixed pay.

The committee also required him to own shares worth four times his salary. At the time of the last annual report (February 2014), he owned more. In fact, he had £7.5m worth of Tesco shares, acquired over the years from Tesco's share and option plans. On his watch, they halved in value. So in other words, he suffered financially exactly as other shareholders did and he deserves praise for keeping such a high stake.

In fact, the fall in share price alone wiped out the salary he was paid over the three years. And that's before tax. Take off 45 per cent income tax and 2 per cent National Insurance Contributions and his "reward" for failure looks more like a personal loss of about £2m.

Or rather it would look like that if it wasn't for a missing ingredient: Tesco - unlike its main competitors - still operates a defined benefit pension scheme in the UK. Older employees are in a final salary scheme. More recent joiners, including presumably Dave Lewis, are on career averages. And that can make an enormous difference.

Just before he became CEO, Philip Clarke had accrued a pension of £415,000, worth £5.9m. Had he been in the career average scheme, a year later this would have increased by 1.5 per cent of his new salary: lifting it to about £432,000. But under the final salary scheme, the pension is recalculated and based entirely on the new salary, so it went up to £573,000, worth £9.7m.

It has to be said, though, that valuing pensions is not a precise science. Basically, you ask how much an equivalent annuity would cost to generate a similar amount. The convention is to use an annuity rate of 5 per cent, so a pension of £573,000 would cost £11.5m. But that's if it's taken immediately. If the pension won't be paid until the age of 60, this calculation has to be discounted back to today's values, which is one reason why Tesco's figures are lower.

The Remuneration Committee could have taken Philip Clarke's pension increase into account in setting hissalary when he became CEO. Or they could have changed his employment contract to career averaging. They did neither. As a result, his salary increase came with a windfall gain worth over £3m. The same applies to the other executive directors that were part of Sir Terry Leahy's legacy; if pensions are included, they were all paid more than market rates.

Philip Clarke then served another couple of years as CEO, and each year of service cranked his pension higher. Tesco's last annual report said that in February, his accrued pension had reached £633,000; they valued it then at £11.5m.

This is of Fred Goodwinesque proportions, but there's not been much fuss about it. Maybe it's considered modest compared to the £887,000 pension that Sir Terry Leahy had accrued in 2011, shortly before he left and which Tesco said was worth £18m.

Others have noted how companies close their defined benefit pensions once the majority of senior managers no longer qualify for them. And since Leahy's executive directors have now all gone, Tesco must be tempted to do something about its final salary scheme. After all, at the last count earlier this year, its pension deficit was £2.6billion.

The fate of Tesco's pensions now rests ultimately with Dave Lewis. An enlightened alternative to closing the scheme completely would be to slap on a cap to protect the majority of Tesco's 314,000 UK employees who are on low pay. For them, it's to Tesco's credit that it's kept it going for as long as it has. It would be a shame if they were to lose out now because of excesses at the top.