In a culture where rising share prices generate high levels of pay, executives tend to gravitate towards the companies most likely to experience sustainable growth. So how can a company that’s going through turbulent times hang on to its high-calibre people and attract new talent? That’s the dilemma facing the company remuneration committees of the many casualties of Covid lockdowns, such as Rolls-Royce (RR.).
In the teeth of the crisis in 2020, both Warren East, Rolls-Royce’s chief executive, and Stephen Daintith, the chief financial officer, accepted temporary salary cuts. For the year as a whole, East ended up receiving less than half the amount that he normally receives. Paradoxically, a drop in pay was his team’s reward for steering the company through what must have been the most torrid year in its history. External events had sunk any chance of achieving their performance objectives, so annual bonuses were zero – and so would be the expected outcomes of all of their outstanding share awards.
There’s a second irony here too. A significant part of the £12.7m that East is reported to have received since taking on his role in mid-2015 has been in shares. He’s expected to build up his shareholding to at least 2.5 times his annual salary so that he personally experiences the gains and pains of investors. He has no choice about this forced investment, and I estimate that share price falls last year lost him £0.8m. Since the take-home pay from the £1.1m he received in 2020 would have been about £0.6m, it’s hard to escape the conclusion that instead of being paid for his intense 2020 workload, he was the one effectively footing the bill for the privilege.
True, this was the year which exposed the weakness of Rolls-Royce’s business model of selling its engines at a loss and receiving payment according to how long they fly. This fails to shift the risk – when airlines ground their fleets, Rolls-Royce’s revenues dry up. For this and other reasons, the company reported an unprecedented loss of £4bn. It had to raise £5bn through bonds, new credit lines, and a heavily discounted rights issue, and it’s making 9,000 job cuts and planning to sell some businesses to raise a further £2bn. Had the Remuneration Committee chosen to pay a discretionary bonus against this background, it would have looked anomalous. Executives have to take the rough with the smooth: investment gains and losses come with their role.
There’s a human side to all this. Salary cuts demotivate. Rolls-Royce’s answer is a new pay policy that squares the circle by stealing a trick from the financial sector. Going forward, salaries have been restored to their previous level, but 30 per cent will now be paid monthly in shares that have to be held for two years. And while East’s salary has been kept whole, cuts planned for his pension allowance have been accelerated to bring it down to the same percentage of salary as the rest of the workforce.
Going forward, Rolls-Royce’s annual bonus and long-term share awards will be merged into a single share plan for both executives and managers. The number of shares they’ll receive will depend on their performance every year, but three fifths of these will then be locked away for another four years and the remainder for three years. The performance will be measured against the key milestones of the recovery strategy: to generate cash, improve operating margins, grow revenues where they can and restructure where they can’t; and keep the workforce fully committed through these periods of radical change.
Overall, the new policy will reduce the maximum that East could receive from almost £10m a year (which he never received anyway) to £4.7m. The company has been quoted as saying that, unlike the more traditional type of plan, this new policy will remove the sort of “lottery win” caused by share prices rising due to “factors largely outside of our control”. But over two thirds of the £3m he would receive for on-target performance will be in shares, and this portion will still be dependent on the share price – ongoing success could yet deliver him investment gains worth more than his pay, or conversely, a lack of progress might instead reap losses.
The new policy came too late for Daintith, whose resignation was announced last August. He has said that he was attracted by the new challenges and the growth potential of Ocado (OCDO), which he joined in March as the new chief financial officer. He added that the prospect of Ocado expanding into new markets was particularly enticing for him, and while pay might have been no more than a nudge, remuneration committees can’t get away from the fact that the share awards awarded by growing companies are likely to end up making their pay more lucrative than in struggling ones.
