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How much is too much?

No Free Lunch

How much is too much?

Five years ago, in his “No Free Lunch” column, Alastair Blair concluded that “WPP hasn’t made anyone other than Sir Martin Sorrell much wealthier over the past 10 years, and nor has its peer group.” During this time, he estimated, Sir Martin was paid over £100m in salary, bonuses and share awards. So what’s changed since?

Sir Martin’s Single Figure of Total Remuneration in the table below shows what he has received over the past five years - £100m in just four years, with another £100m likely in 2015 and 2016. WPP’s shareholders might seem ambivalent - those holding 60 per cent of the shares objected strongly when Sir Martin received £12m, but three years later they weren’t so fussed when he received £43m. A change of share plan and a rise in WPP’s share price might have had something to do with it.

 

Sir Martin's single figure total remuneration

YearAmount paidKey shareholder votes at the subsequent AGM (June the following year)
2011£11.9m60 per cent against
2012£17.5mNew share plan backed by 84 per cent
2013£29.8mNew pay policy backed by 82 per cent
2014£42.7m20 per cent against
2015£70.4mJune 2016: AGM not yet held
TOTAL£172.4mJune 2017: New pay policy to be proposed

 

It’s worth spelling out in full what Sir Martin raked in last year: £70,416,000. That trumps previous years and it’s a staggering amount. It’s about 2,500 times the national average pay in either the UK or the US. So how has this come about?

 

Look before you leap

According to WPP, the high pay in 2015 was driven by “the maturing of a five-year LEAP award and the increase in the Company’s share price…” LEAP stands for Leadership Equity Acquisition Plan: in plain English, their former long-term share award subject to performance conditions. So what exactly happened?

■ In 2011, for a stake equivalent to their salary, benefits and year’s bonus, executives were awarded WPP shares worth a massive five times as much. For Sir Martin, this worked out at £23.6m (and incidentally was equivalent to 18 times his then £1.3m salary).

■ The five-year performance condition depended only on WPP’s share price and dividend performance (TSR, or total shareholder return) compared with its major global competitors, weighted by size. Except that WPP adjusted share prices when mergers happened. It might seem fair to iron out the takeover premiums for Aegis and Arbitron, but the whole point of TSR ranking is to replicate the experience of investors - and like it or not, an investment in either of these companies would have produced better returns than the ones WPP included in its performance condition.

■ The upshot was that WPP outperformed and all the shares were released. Throw in more shares for the dividend and, with the share price increase over the five years, that original £23.6m award was transformed into £62.8m. So every £100 of shares at the start of the period had become worth £266 by the end. That’s a management-equivalent TSR of 166 per cent.

Sir Martin actually received more than £70.4m in 2015. That’s because the conventions used to calculate the Single Figure exclude certain items. Half his bonus is paid in shares, and when his 2012 bonus shares were released last year they had gone up in value by £0.6m. A quibble? May-be, but that £0.6m alone is over 20 times what the average person earns in the UK.

Nor does the Single Figure include share ownership. A condition of Sir Martin’s job is that he has to own WPP shares worth six times his salary: with dividends, these would have increased in value by another £1.5m last year. In fact, he has a beneficial interest in another 18m shares in his own right: dividends and the share price rise would have increased the value of these in 2015 by somewhere approaching £50m.

“With hindsight, LEAP was excessive and we are grateful to shareholders who pointed this out to us in 2012. We responded by introducing the more moderate Executive Share Performance Plan (EPSP) the following year.” That’s what WPP’s directors might have said, but of course, they daren’t. What they actually said in WPP’s annual report was that they are “content that the LEAP program has performed as intended and in the manner approved, with very strong share returns and share price performance delivering significant value to both share owners and management”…

 

More jam tomorrow

So what about the future? Sir Martin’s pay package for 2015 was £7.6m in salary, benefits and bonus, plus an EPSP share award initially worth a potential £11.2m. The EPSP has three performance conditions: TSR, earnings per share and return on equity. The first awards under this plan were made in June 2013, but they won’t be tested until December 2017; any payouts will be in 2018. So far, it looks as though most of the shares will be released - but, of course, WPP cannot escape the economies in which it operates and much can happen between now and then.

The LEAP moneymaking machine has another year to run and, with a fair wind, it could deliver Sir Martin £40m or so in 2016. The rest of his pay could take this up towards £50m. Much depends on the share price. At least it will look like a pay cut in time for the June 2017 AGM and that’s a key date. It’s when WPP’s pay policy will next be up for review.

Institutional investors will be consulted in the meantime. They might wish to consider how much a chief executive deserves for success and work back from that, factoring in different share price scenarios, to determine at what level they consider the initial share award should be set. It would also help if there was a consensus on the most appropriate performance conditions for WPP, how much pay should be at risk and how testing targets really are.

 

A taxing question

Maybe we concentrate on gross pay because it is confusing enough without adding extra complications, but here’s another one anyway. We already have the timing issue: the difference between future pay and past pay. Share awards subject to performance conditions are for the future and so are excluded from the single figure. Share awards from the past are included if they have become “taxable events” (because their performance conditions were passed) during the year. The single figure actually represents what someone notionally receives as pay before tax.

The complication is that “taxable events” are not necessarily taxed at the time. The normal convention is that tax only becomes payable when the person can sell the underlying item. One way to delay a tax liability is to use options: the shares can only be sold (and give rise to tax) when the option is exercised and the participant is often given 10 years to do this. If it’s a nil-cost option, it won’t cost anything to exercise either, so it’s equivalent to making shares available but holding them back until the participant wants them.

Sir Martin has been allowed to push back several years’ share awards (4.7m shares in total). He’s missed out on dividends, but that will be made up with extra shares when he chooses to take full ownership. The exception is an award made twenty one years ago (yes, 1995) which pays him dividend-equivalents each year (£1.5m in 2015). He has until 30 November 2017 to take full ownership of all these outstanding awards. A curious situation, perhaps, but directors say that shareholders approved all of this.

Since personal tax is fast becoming a more important matter of corporate governance, it’s also worth mentioning the shares that Sir Martin has transferred into his charitable foundation, of which he and his family are all but one of the trustees. The annual report says that he has no beneficial interest in these 3.5m WPP shares (worth over £50m), although not how much tax was paid when they were transferred. Last year, Civil Society News, which specialises in charities, reported that this foundation had spent just £416,000 on charitable grants in the previous two years.

 

Success and excess

Sir Martin always robustly defends his pay. Shareholders backed his pay plan. The company has done well and he should be rewarded for it (his pay of £100m was just 1 per cent of the £10bn increase in WPP’s value over the same period). Most of what he earns stays invested in WPP and his WPP shareholding represents most of his personal wealth. If that’s skin in the game, he’s apt to say, then 'mea culpa'. He thought that was the object of the exercise.

Only 14 per cent of WPP’s 2015 profits were generated in the UK and Sir Martin says, with some justification, that he should be judged globally. If WPP outperforms its peers, he deserves to be paid more than them. The problem with their pay influencing his is that his pay also influences theirs. The mindset seem to be: if pay is your reward for doing a good job, then the higher your pay, the more you are appreciated and the greater your human worth. But that’s a weakness too. More skin in the game is one thing. Being thick-skinned about high pay is quite another.

And who knows? It might help his case if he were to say how much personal tax he has paid globally over the years on his £172.4m.

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