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Up, down or sideways
What’s really happening
to executive pay?
January 2015
What’s really happening to executive pay?
The data shows continued restraint in executive
pay, despite some headlines to the contrary.
However, pressure is beginning to build.
Executive pay is a complicated beast, which makes it tough to
interpret trend data. Most executives receive a salary, some
benefits, a bonus (part of which will be deferred into shares)
and at least one long-term incentive plan. Awards made by a
remuneration committee in any given year can crystallise for
the executive one, two, three or more years later. The value at
the time they crystallise normally depends on how the
company does against performance conditions. Awards are
often made in shares, so the value depends on the share price
too. This creates a lot of volatility, and consequently noise in
the data, which makes interpretation difficult.
In this short briefing we aim to demystify some of the analysis
and give a clear view of what is happening to executive pay.
Valuing executive pay
What figure should you ascribe to an executive’s pay? Four
different approaches lead to very different answers (see
appendix for more details):
• Target pay is the level of pay that an executive could
receive from their package assuming a target level of
performance
• Maximum pay is the level of pay that an executive could
receive from their package assuming all performance
targets are met in full
These approaches measure the intended pay opportunity that
a remuneration committee is setting for an executive. As such
they are commonly used in benchmarking when remuneration
committees are setting an executive’s pay. These measures are
also the best reflection of the decisions that remuneration
committees are making today about the intended future
trajectory of executive pay.
However, these approaches don’t reflect what is actually
delivered from pay plans, which depends on how well
companies do against performance targets and also on how
the share price changes for awards which are paid in shares.
Two approaches which address this are:
• Crystallised pay, which measures the value of pay
received at the point at which performance is measured.
This is the basis of the ‘single figure’ for executive pay that
companies must now disclose in their Directors’
Remuneration Report. It will generally comprise a mix of
pay elements: salary and bonus for the year in question
and the value coming out of long-term incentive plans
awarded several years earlier, but which have only now
come to the end of their performance period.
• Realised pay, which measures the gains an executive
actually receives in their pocket. This approach only
measures a pay element when it is delivered to the
executive or, in the case of share options, when they
actually exercise the option. Therefore this measure will
typically include pay elements originally awarded in a
number of different years.
Both these approaches are a closer reflection of what an
executive actually receives. However, they are highly
influenced by what has happened to the company’s share price
over the period since long-term incentive awards were made.
Whether this figure goes up or down is therefore as much to
do with what has happened to stock markets as it is to do with
remuneration committee decision making.
Measuring changes in executive pay
If the different ways of measuring executive pay weren’t
complicated enough, more difficulties arise when looking at
how to measure changes. There are three main approaches.
• Compare average executive pay from one year to the next
• Compare median executive pay from one year to the next
• Compare pay from one year to the next by individual and
look at the median change
Comparing an average or median pay figure from one year to
the next shows how the typical pay package for a FTSE-100
CEO has changed, but can be distorted by a number of factors:
• The companies in the FTSE-100 may differ from year to year
• The executives in post may differ from year to year
So these overall statistics can be distorted by changes in the
population of companies being looked at or by changes in the
executives in post, due to joiners or leavers.
The use of average rather than median is even more
problematic. Whereas a median looks at the mid-point of the
data set, and so isn’t affected by outliers, a single extreme case
can distort the average. For example, in 2009 Bart Becht, then
CEO of Reckitt Benckiser was reported to have ‘taken home’
£90m, most of which resulted from exercise of share options
accumulated over a decade. This single data point increased
the average realised pay for FTSE-100 CEOs by nearly £1m
relative to the median figure. This is why average realised pay
is generally used by commentators when they want to create
the impression of the greatest increase in executive pay.
Even the median has problems – in a volatile and widely
dispersed dataset, the median can move a significant amount
due to a change in one company, even if the overall shape of
the dataset hasn’t changed. This is particularly a problem with
crystallised and realised pay measures, where long-term
incentives give rise to a lot of volatility.
The most reliable way to look at pay trends is to analyse
changes by individual and then to look at the median of these
changes. This gives the most reliable picture of how pay is
changing year on year for individual executives, and is also
the most robust measure of trends and gives the best insight
into remuneration committee decision making. This is the
measure we focus on in this summary.
So what’s the story?
The table below summarises the most recent results for FTSE-100 CEO pay from our Executive Remuneration Survey. In each
case the median increase is shown for those executives who were in post for at least two years to enable a consistent year on
year comparison.
Target pay for 2014
Value (£000s)
Base salary
Increase (%)
850
Base + Bonus
Maximum pay for 2014
3
Value (£000s)
2.4
850
1,691
2,484
Base + Bonus + LTI
3,021
4,655
Total remuneration
3,225
1
2
2.5
4,909
Actual pay for 2013
Value (£000s)
Actual base salary
Actual bonus
Crystallised pay
4
Increase3 (%)
841
N/A
1,060
3.6
4,049
2.7
LTI = long-term incentive plan, comprising shares with performance conditions, options, bonus match
Total remuneration = base + bonus + LTI + pension + benefits
Median increase based on CEOs in post for two full years to enable like for like comparison
4
Single-figure as disclosed in Directors Remuneration Report for CEOs in post for the full year
1
2
3
The following key messages come out of the data:
• Target levels of pay increased broadly in line with inflation
or less at around 2.5%
• The maximum opportunity for CEOs increased slightly
more rapidly at 5%, reflecting a few cases of increased
maximum incentive levels
• Bonus payments were up slightly last year, by just under
4%, following two years of falls
• However, total crystallised pay (the new ‘single figure’
basis) increased only 2.7% at median
• Over a quarter of FTSE-100 CEOs received no pay rise and
one in 10 did not receive a bonus
Overall this data represents a fairly flat picture in aggregate
for CEO pay. One point of interest is the difference between
the target level of pay, at £3.2m and the total crystallised pay
at £4.0m. What explains this difference? In essence there are
four potential drivers of the difference:
• Above or below target achievement against bonus targets
• Above or below target achievement against long-term
incentive plan targets
• Share price growth, which affects the value of long-term
incentives in the crystallised pay calculation but is
excluded from target and maximum pay estimates
• Differences between current year award levels, which
drive target values, and award levels in previous years
which are now emerging into crystallised pay, which can
also be affected by changes in incumbent
Increase3(%)
2.4
5.0
It is not possibly precisely to disaggregate all of these influences, but the chart below shows an estimated
reconciliation between the median figures above:
Remuneration (£000s)
0
1,000
2,000
3,000
4,000
5,000
6,000
Maximum remuneration
Target remuneration
Base
Bonus outperformance of target
Bonus
Long-term incentive
LTI* outperformance of target
Benefits
Single figure excluding share price
Total rem
Share price growth on LTI*
Crystallised pay (single figure)
*Long-term incentive plan
Performance has been above-target on incentives (particularly
annual bonus) but the biggest factor driving the difference
between target pay and crystallised pay is movements in share
price which feed through into crystallised long-term incentive
values. The median level of total shareholder return for the
companies analysed was 14% pa over the relevant long-term
incentive plan performance periods, meaning that over three
years the value of shares underlying a long-term incentive
plan typically increased by around 50%. In less favourable
market conditions this increase will be lower or could even
be reversed.
Pressure building?
Overall the data suggests that remuneration committees
continue to be restrained in their decision making, reflecting
the current economic, political, and investor climate around
pay. The key signals of decisions remuneration committees are
making today – base salary movements, target incentive
awards, and bonus payments – all show relatively modest
increases in the 2% to 4% range. This is acting to keep
executive pay flat in real terms and broadly aligned with
wider workforce increases.
Of course there are significant variations within this, and here
we start to see some pressure beginning to build. Although
increases to base salaries were fairly uniformly subdued,
increases to bonus payments, and to target and maximum
total remuneration levels showed wide variation, with some
significant increases.
Increase on prior year
Lower quartile (%)
Base salary
Median (%)
Upper quartile (%)
0.0
2.4
2.9
Actual bonus
(5.8)
3.6
37.2
Target total remuneration
(0.7)
2.5
9.6
0.0
5.0
14.3
(19.6)
2.7
31.9
Maximum total remuneration
Crystallised pay
Although median bonus and crystallised pay increases were
3.6% and 2.7% respectively, one in four CEOs received
increases above 30% (in the case of bonuses often from a very
low prior year comparator). Equally double digit increases in
target or maximum levels of future remuneration were seen at
a quarter of companies. It’s possible that these will result in
higher bonus and total crystallised pay outcomes in future
years. At the same time, it’s possible these changes reflected
one-off adjustments being made as companies approved new
binding policies for three years rather than signifying a
changing trend.
Conclusion
Overall, when carefully analysed on a consistent basis, the
data shows that executive pay continues to operate in an
environment of restraint. But there are signs of inflationary
pressure building in the system. We continue to believe it’s
unlikely we’ll see a return to the levels of executive pay
increases that were seen before the financial crisis. As
outlined in our publication What goes up must come down, the
forces that drove executive pay upwards over the two decades
preceding the crisis have abated or even gone into reverse.
It seems most likely to us that executive pay will, largely, move
sideways in real terms over the coming years, although there
will be ups and downs along the way. And it’s probably
important that it does so. Austerity is guaranteed to continue
whoever wins the General Election. Real wages are now some
10% below pre-crisis levels and have yet to experience
sustained increases even at the level of inflation.
Trust in business is at a low ebb, and is damaged by the
perception of unjustified rewards to executives that contrast
with the experience of the wider workforce.
British companies are highly international and need to be
competitive in that context, and to pay in a way that attracts,
retains and motivates the best executives. But at the same
time trust needs to be rebuilt and societal acceptance of
business – the licence to operate – needs to be nurtured.
Remuneration committees and executives have exercised
commendable restraint since the financial crisis. They need to
be vigilant to ensure remuneration remains fully justified by
performance, and to avoid returning to the inflationary
environment of the past.
Life isn’t going to get easier for remuneration committee
chairs any time soon.
Appendix
Different approaches to valuing executive pay
Target pay
Maximum pay
Crystallised pay
Realised pay
Definition
The level of pay that
an executive could
receive from their
package assuming a
target level of
performance
The maximum level of pay
that an executive could
receive from their package
assuming all performance
targets are met in full
The total level of pay
that has crystallised for
an executive based on
achievement against
performance targets over
the year
The total level of pay
actually received in their
pocket by the executive
over the year including
share option exercises
Usage
Commonly used in benchmarking as these
measures give a good indication of the level of pay
opportunity a remuneration committee intends to
offer its executives
Prescribed format for
measuring total pay in
the Directors’
Remuneration Report
Not a widely used
measure other than by
some niche survey
providers
Crystallised pay
Realised pay
Valuation approach
Target pay
Base salary
Amount paid in the year in question
Benefits
Bonus
Deferred bonus
Long-term
incentives
Maximum pay
Potential value
assuming target
performance including
any portion deferred
into shares
Maximum possible level
of bonus assuming all
targets met including any
portion deferred into
shares
Actual amount paid,
including any portion
deferred into shares
Potential value of
award assuming
mid-level performance
against performance
targets but ignoring
future share price
growth
Potential value of award
assuming all performance
targets met in full but
ignoring future share
price growth
Value of award at the
point performance
targets are assessed,
based on actual
achievement against
targets and the share
price at that time
Actual cash bonus
received, excluding
deferred portion
Deferred bonuses from
previous years that are
actually received in the
year
Value of actual award
received by the executive
at the point it vests or
when they choose to
exercise it (in case of
options)
Contacts
Tom Gosling, Head of Pay, Performance & Risk
Fiona Camenzuli
Carol Dempsey
M: +44 (0) 20 7212 3973
E: [email protected]
M: +44 (0) 20 7804 4175
E: [email protected]
M: +44 (0) 20 7212 4641
E: [email protected]
Sean Drury
Dean Farthing
John Harding
M: +44 (0) 20 7212 5552
E: [email protected]
M: +44 (0) 20 7212 5323
E: [email protected]
M: +44 (0) 161 247 4542
E: [email protected]
Isabel McGarvie
Phillippa O’Connor
Marcus Peaker
M: +44 (0) 141 355 4060
E: [email protected]
M: +44 (0) 20 7213 4589
E: [email protected]
M: +44 (0) 20 7804 0249
E: [email protected]
Julian Sansum
Jon Terry
Paul Wolstenholme
M: +44 (0) 20 7212 1652
E: [email protected]
M: +44 (0) 20 7212 4370
E: [email protected]
M: +44 (0) 20 7212 6225
E: [email protected]
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