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Bosses' pay plummets as workers’ wages rise... or did it?

Bosses' pay plummets as workers’ wages rise... or did it?
September 19, 2019
Bosses' pay plummets as workers’ wages rise... or did it?

And that’s a shame, because there’s much more to this than meets the eye. The diversity is worth noting. Fifty-six FTSE 100 chief executives received less in 2018 than in 2017. Forty-three received more. The biggest apparent faller was at Melrose Industries (MRO) (down by £42m, or 98 per cent); the biggest riser was at Royal Dutch Shell (RDSB) (up by £10m, or 128 per cent). And high pay is still high. Collectively in 2018, the top 25 chief executives received more than the other 75 put together. Before tax, most received over 100 times more than the national average wage.

The report, compiled by think-tank the High Pay Centre (HPC) and the Chartered Institute of Personnel and Development (CIPD), a body for human resources professionals, ranks what the chief executives received in descending order and focuses on the median, the level at which half received more and half received less (the median’s used rather than averages to avoid the distortion of outriders). In 2018, this mid-point was £3.46m (received by Andrew Mackenzie, chief executive of BHP (BHP)). But, since constituents of the FTSE100 change over the year, what should this median be compared with? The answer is the mid-point of the 92 companies that were in the index both this year and last. The 2017 median was £3.97m, received by Andy Ransom, the chief executive of Rentokil Initial (RTO)

 

Pay at risk

But look back at last year’s report, and you’ll see that Mr Ransom’s 2017 'pay' was listed as £4.37m. It’s been restated. Why? The answer goes to the heart of what most drives executive pay – the provisional award of shares that’s often called a long-term incentive plan (LTIP). How well executives deliver the company’s long-term goals during the years after the LTIP award (typically three) then determines how many shares they receive.

A third of Rentokil’s LTIP depends on earnings per share, and two-thirds on total shareholder return (TSR). TSR echoes what shareholders would receive if they’d invested in the company on the award date and reinvested the dividends in further shares. Rentokil ranks its TSR against its relevant FTSE 350 peers. Would you do better investing in Rentokil or its competitors? That’s what this tests.

The critical factor for Rentokil’s TSR is the closing price on the day that the share award matures. Fair enough, you might think. That’s close to what you’d get if you sold Rentokil shares on the same day. The issue is that relatively small price movements can significantly shift positions in the ranking, which in turn governs how many shares Mr Ransom receives. And that’s what happened in 2017. Rentokil has to publish its annual report before the final outcome is known, and estimated too high a price for its shares. A subsequent dip reduced the number released to Mr Ransom, plus, of course, the lower price meant that his shares were worth less, too. The estimate had overegged his LTIP by a seventh (£0.4m). 

 

Two meanings of pay

This highlights the ongoing debate about whether such a volatile arrangement really is pay. That’s because by 'pay' we normally mean the pay package, which is what might be paid in the future. But what the HPC/CIPD report looks at is the 'single figure of total remuneration', which is something else. It’s what was actually received.

Shares at Melrose, for example, are awarded every four years, so its chief executive, Simon Peckham, receives relatively slim pickings for three years (£1m in 2018) and bumper payouts every four (£43m in 2017). To call what he received in 2018 his 'pay package' would be misleading.

 

Skin in the game

The argument is that much of this 'single figure' is not actually pay at all. A footnote in Rentokil’s annual report casually says that £1.3m of Mr Ransom’s maturing share award in 2017 – that’s over half of his award and a third of what he eventually received – “can be attributed to share price appreciation”. Being paid in shares is like being paid in cash and being forced to invest it in the employing company’s shares. At prudent companies, subsequent gains come for free. They’re paid for by the market.

It would lead to a wider understanding if companies trumpeted this more loudly. Or as the CIPD puts it, the outcomes of “excessively high chief executive pay packages damage trust in business as too often they are the result of external events, for example movements in an organisation’s share price, which are unconnected to the contribution of the individual chief executive”. That looks at pay through the prism of the individual. But as investors, we can’t avoid being exposed to these same external events either – and they could go against us. We want those running our companies to continue to be similarly exposed – the investors’ imperative on executive pay is for it to be aligned with shareholder risk.

There are countless debates about the size of the initial share awards and whether performance tests are sufficiently demanding. Was Mr Ransom’s heavily market subsidised £4m over generous? Possibly. But Rentokil’s shareholders, who’ve seen the market value of their company quadruple to over £8bn since he came on board, aren’t complaining.

 

Gearing for success

The table below picks out those FTSE 100 chief executives who received the most last year, those who received the least, plus a few in the middle. What this sample illustrates is:

  • A relatively tight range of fixed pay (salary, benefits and pensions combined).
  • A strong link to short- and long-term performance, which accounts for over 85 per cent of pay received at the top end, just over 50 per cent in the middle, and, in general, hardly any at the bottom of the table.
  • Most of this correlation is due to long-term performance (LTIPs)

Single figure of total remuneration (SFTR) for FTSE chief executives in 2018 (£000s)

 

Company

SFTR

Fixed pay

Annual bonus

LTIP payout

Per cent due to performance

Per cent due to LTIP

1

Persimmon

 38,967

 888

Not awarded

 38,079

98 per cent

98 per cent

2

Shell

 17,771

 1,707

 2,654

 13,456

90 per cent

76 per cent

3

Reckitt Benckiser

 15,207

 1,321

 3,391

 10,495

91 per cent

69 per cent

4

Anglo American

 14,669

 1,749

 1,754

 11,166

88 per cent

76 per cent

5

AstraZeneca

 11,356

 1,747

 1,858

 7,751

85 per cent

68 per cent

        

49

National Grid

 3,519

 1,238

 919

 1,491

53 per cent

47 per cent

50

BHP Billiton

 3,461

 1,642

 1,819

Failed test

53 per cent

0 per cent

51

Halma

 3,429

 859

 980

 1,609

53 per cent

47 per cent

        

94

Next

 1,153

 1,153

Waived

Failed test

0 per cent

0 per cent

95

Glencore

 1,121

 1,121

None. Significant shareholder

0 per cent

na

96

Marks & Spencer

 1,120

 1,044

Not awarded

 79

7 per cent

7 per cent

97

Melrose

 1,049

 583

 466

Not this year

44 per cent

0 per cent

98

Fresnillo

 661

 661

Not awarded

No LTIP

0 per cent

na

99

Admiral

 404

 404

None. Significant shareholder

0 per cent

na

Source: Investors Chronicle

Shifting perceptions

The report reminds us that respondents to a recent Government Green Paper on Corporate Governance “expressed concern that LTIPs are not adequately aligning executive remuneration with long-term company performance”. The table suggests that this is due to perceptions rather than reality. Maybe respondents were swayed by aberrations (such as Persimmon (PSN)). Or they could simply have been reacting to recent events, forgetting that LTIPs are assessed on the cumulative performance over several years.

Or maybe concepts of performance differ. The report says “returns to shareholders are crude indicators of the company success for its other stakeholders”. That’s not to say that their interests are ignored. Stakeholder measures, such as customer satisfaction and employee engagement surveys, are often included in assessments for annual bonuses. And at dynamic companies, all-employee share plans enable every worker (and not just executives) to benefit from share price gains.

“The continuing use of LTIPs is surprising for various reasons,” the report goes on. “For one, the term ‘incentive’ plans could be considered misleading, when receiving one is the norm rather than the exception.” After all, every year about 83 per cent (so not far off all) chief executives receive shares from their LTIP. But this varies. Within each company, the actual number of shares, which depends on their perceived performance, tends to fluctuate from year to year and in 2018, given the economic headwinds, fewer were probably released. The FTSE 100 itself also fell by about 12 per cent, so it’s hardly surprising that the value received by those paid in shares went down.

The term ‘incentive’ certainly is misleading, for later on the report says “...there is little evidence as to whether so much money in the form of LTIPs and bonuses is needed to motivate chief executives to improve [their] performance.” This is undoubtedly true: the term ‘incentive’ implies that performance-related pay is supposed to motivate, and that’s a common misperception. In “Drive (The surprising truth about what motivates us)”, first published 10 years ago, Daniel Pink showed that in knowledge roles, money doesn’t motivate. The purpose of LTIPs and bonuses is quite different: they’re intended to keep executives’ eyes on the ball – to maintain their focus on delivering their company’s long-term objectives, and to gear the risks in their pay to those run by shareholders.

 

Influence

The report deserves to be read more widely, not least because it influences political thinking. It expresses valid concerns about pay inequality, and urges that scrutiny should go beyond just FTSE 100 chief executives, while repeating some common misunderstandings. All are worth noting.

Perceived pay inequality has been festering for some time. Many companies already have in place some of the report’s recommendations, but how widely is this known? They could do more. The moral is simple. We saw with Brexit how a failure to counter the remorseless drip of negative publicity over many years led to disruptive consequences. Unless companies challenge external pay perceptions more effectively in the media, they too risk having disruptive consequences applied to their own executive pay and to the way they operate.

The report can be found on: http://highpaycentre.org/files/CIPD_HPC_FTSE_100_executive_pay_report.pdf