By Jessica Tasman-Jones
This article is brought to you by Agenda, an FT Specialist publication that focuses on corporate boards
Performance targets for executives are under fresh scrutiny after a sharp rise in bonuses for FTSE 100 bosses in 2021.
Economic uncertainty led boards to set easy-to-achieve performance targets in 2020, experts say.
The median bonus was 82 per cent of the possible total to which an executive could have been entitled, compared with 44 per cent in 2020, in the midst of the pandemic, and 66 per cent in 2019 before Covid-19, PwC says.
Bonuses were the main driver in median total pay. They increased by 34 per cent from 2020 to £4.1mn, the consultancy says.
Tom Gosling, executive fellow at London Business School, says one reason that boards set easier targets for 2021 was the human tendency to look on the bleak side.
Most companies with a December 31 year-end would have set targets in late 2020, before vaccines had brought Covid cases under control, and confirmed them early in 2021.
Phillippa O’Connor, reward and employment leader at PwC UK, says boards have been incorporating economic uncertainty “into their ranges when setting their financial performance expectations for the year ahead”.
Boards may also have wanted to compensate executives for missed bonus and long-term incentive awards during the pandemic, or as part of efforts to retain them.
CEO turnover rose dramatically worldwide in 2021, according to executive search firm Heidrick & Struggles, although in the UK there were only six appointments in the first half of the year among FTSE 350 firms. This was in line with half-yearly figures at the start of 2018.
In most cases investors do not challenge boards over high bonuses unless there are exceptional circumstances, Gosling says. He cited as examples Greencore’s failure to repay government pandemic support and Standard Chartered’s record UK regulatory fine.
However, the cost-of-living squeeze facing the wider workforce is likely to fuel a sense that boards have been too soft and let pay bounce back too quickly from pre-pandemic levels, Gosling says.
Shareholders in Plus500, a FTSE 250 fintech company, rejected its remuneration report this month after ISS, the proxy adviser, questioned whether performance targets were “suitably stretching”.
Rodion Skovoroda, a senior lecturer at Open University Business School, says that instead of setting softer targets in times of uncertainty, boards should base bonuses on relative performance, a practice that is widespread in FTSE 100 and S&P 500 businesses.
For example, UK executives could be compared with their peers in the FTSE 100 or a group of sector competitors on a relative total shareholder-return basis. This usually covers a three-year period.
This can curb unwarranted levels of pay in buoyant equity markets while protecting remuneration from factors beyond executives’ control during bear markets, Skovoroda says.
The challenge for boards is to avoid selecting a peer group that is too broad to be a suitable comparator, or to let CEOs influence the selection of companies against which they will be benchmarked.
But many investors will want CEO pay to be aligned with absolute share price returns, Gosling says.
In 2016, shareholders rejected BP’s remuneration policy because Bob Dudley’s pay increased as the share price fell. The board had sought to decouple his remuneration from the falling oil price because it was out of his control. But for investors, it failed a fairness test.
Ideally boards might have scaled back 2021 awards when it became clear that the situation regarding Covid-19 was improving, Gosling says, although that would have been tough to do.
Luke Hildyard, executive director of the High Pay Centre, a UK think-tank, says the fact that pay levels surged as the economy rebounded from the pandemic shows that variable pay is driven more by circumstances than CEO skill.
Boards are setting conservative targets because they “just want to make sure their executives get the kind of pay out they’re expecting”, Hildyard says.
This article is based on a piece written by Melissa J Anderson for Agenda.