Recession rattles the bonus system

Anthony Hilton
7 Sep 2009

Performance pay schemes for executives were, according to the late Alastair Ross Goobey, the one-time head of pension fund manager Hermes, very much like the Caucus race in Alice in Wonderland. No one knew where or when the race began; no one knew where or when it ended; everyone got a prize.

Remuneration consultants say it is not like this at all. Performance pay is closely measured, and executives only ever get what they deserve.

Well, the facts suggest otherwise if only because, while performance varies wildly between different companies in the FTSE 350 — as you would expect — executives almost always get about 70% of their maximum bonus allowable under their performance scheme. It does not seem to matter how the company has performed, nor does it matter what the details of the individual's performance scheme are because in company after company and year after year, 70% of the maximum possible bonus is what is paid out.

This time, it is like Goldilocks where 100% would be thought too hot —because people would think the target had been too easy — 50% would be deemed too cold because it would suggest the executive was not much good, but 70% seems just right. Anyone who has ever served on a committee will know why the answer is always like this.

But today for the first time in years there is a glimmer of evidence that the mould may be broken. The worst recession in a generation, which has seen profits plunge and unemployment soar, has given boards pause for thought and led some of them to temper the hitherto remorselessly upward march of executive pay.

The evidence comes from Deloitte in its annual report on the remuneration of executive directors, which it published today. This says that more than 70% of the companies in the FTSE 350 have implemented a salary freeze for executive directors. The average increase including those receiving zero is likely to be between 1.5% and 2%, which is significantly lower than the 6% to 7% that was hitherto the norm.Deloitte's Carol Arrowsmith, one of the leading remuneration specialists in the country, says: “This is the first time in a good many years that we have seen some executive salaries frozen, and even more unusually we have seen instances of some taking a salary cut.”

There is an irony in this which should not pass unnoticed. This is that in the good times it was often quite easy for executives to hit their targets and there was often nothing exceptional in their performance in doing so. This year, conditions have been very much tougher, and most businessmen have worked harder than they have ever done previously in their lives. In keeping their businesses afloat in these difficult times, these people even when they have not hit all the numbers have delivered far more value to their shareholders than they did in the easy times. But it is unlikely that gets reflected in their pay.

There is evidence, however, that some companies are taking that on board. According to Deloitte, one in four companies plans to change its performance criteria for the coming year to reflect the different economic environment. Some companies are putting more emphasis on balance-sheet measures and introducing targets based on cash flow and debt management.

Others want more focus on operational efficiency and the development of new business lines. The net result is a move to more qualitative measures of performance, which will demand more judgment from the remuneration committee in due course on whether the executive has done enough to merit a payout.

But don't let us shed too many tears for them. Though Deloitte found evidence that salaries were frozen, it discovered much less evidence that there had as yet been a serious reining-back of bonuses — and bonuses these days are at least as much as and often up to twice salary. So what they lose on the salary swings they may well continue to make on the bonus roundabouts, which continue at a merry old pace. As Deloitte observes, while the potential bonus that may be earned has not typically increased this year, in most cases it has not decreased either. They continue to pay out at around two thirds of potential.

Arrowsmith's take on this is interesting. She says this year's bonus largely reflects last year's results, when most companies were still doing quite well. She points out too that not all companies have been hit as hard or as early as finance and property, and in these sectors where the pain did come early bonuses are just about one third of the maximum.

Some might take that as a sign the system works, others might be more sceptical. Shareholders in finance and property companies, whose shares have dropped 90% in value, have seen their dividends shredded and who have then had to pour in more of their capital via rescue rights issues to keep the businesses afloat, might wonder why the executives got even 30%. If that performance justifies a bonus payment, what on earth would these people have to do for them to be considered not to have earned a bonus at all?