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Royal Dutch Shell came under fire for offering executives retention bonuses

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Shareholders and boards in bonus face-off

By Kate Burgess and Brooke Masters

Published: October 16 2008 03:00 | Last updated: October 16 2008 03:00

After years of investor complaints that big UK companies were throwing too much cash and stock at top staff, boards of directors are bracing for a new battle: how to handle bonus plans that do not pay out.

On one side, corporate managers are worried about motivating and retaining top talent at a time when many of them will be taking sharp cuts in their incentive pay because of missed earnings and profits targets.

On the other, investors are warning they will be more hawkish on excessive pay awards that are out of kilter with a faltering economy. Some are looking at ways of clawing back pay where companies and executives are found to have failed.

“Boards are caught between Scylla and Charybdis,” says Robert Swannell, who sits on the boards of 3i and British Land. “Shareholders don’t want compensation schemes to be rebased simply because the markets have fallen.

“However, in this case, markets have fallen in response to a completely different set of economic realities to those that existed when many schemes were put in place.”

For the past three years, annual bonuses were practically a given: more than 95 per cent of FTSE 350 companies paid at least some sort of a bonus. But the rapid onset of economic hard times has wreaked havoc on many companies’ revenues, profits and earnings per share, currently the critical measures for most annual bonus plans. Falling markets have had an equally tough impact on restricted stock plans that pay out based on share prices.

A survey by the Watson Wyatt consulting firm among its clients and FTSE 100 human resources directors found that most companies are sticking to their bonus criteria for 2008.

“Obviously bonuses are going to be smaller and performance shares are not going to vest,” says Chantal Free, a Watson Wyatt senior consultant.

That will defer this year’s battle over corporate incentive pay for several months, when companies are expected to start consulting with investors, ahead of the publication of annual reports and the annual advisory vote on pay.

In general, the Watson Wyatt survey found that the worse a company performs, the more likely it is to review its compensation policy. Six out of 10 companies where performance is likely to be 50 per cent down have already changed or are considering changing their remuneration policy.

“This is definitely on remuneration committees’ radar. It doesn’t matter whether there is a recession or not. You still have to retain and motivate your best people,” says Bill Cohen, a partner at Deloitte. “It is very challenging if you have good people and the only way [for them] to increase their remuneration is to move.”

In some cases, plan changes will have clear benefits for shareholders. The senior managers of Land of Leather recently announced that they would defer their salaries until the struggling furniture company got back on its feet.

“We are very aligned with shareholders in terms of the upside,” says Clive Hatchard, chief financial officer.

But at other companies, pay has been developing into a flashpoint in relations with shareholders. Many investors began to express growing unhappiness that companies looked to reduce and soften performance targets ahead of the expected downturn.

“The one thing we do not wish to see is reward for failure,” says Peter Montagnon, director of investment affairs at the Association of British Insurers. Boards “need to be confident that they are not paying more than is necessary”.

HSBC came up against investors in May when it asked for their approval to lower performance targets on executive long-term incentive plan bonuses and increased the potential total remuneration. HSBC said it would freeze basic salaries.

Royal Dutch Shell came under fire for offering executives retention bonuses, sometimes known as “pay for respiration”, and HBOS drew criticism for increasing a short-term incentive scheme while reducing the hurdle rates for a long-term incentive scheme.

“The economic environment has changed in the past few months and institutional investors are much more on their mettle,” says Robert Talbut, chief investment officer at Royal London Asset Management.

“If companies have any degree of political nous they won’t be pushing for more generous remuneration packages in the current economic environment.”

Pay consultants say some companies will take the view that incentives for long term performance is so hard to get right, that they will rebalance programmes to emphasize shorter-term targets. Bonuses will also be in the form of locked-in shares rather than cash.

Rob Burdett, principle at Hewitt New Bridge Street, the pay consultants, says company boards could go off in different directions to keep talented executives. “This may lead to some unusual pay scheme structures, for example, one-off recovery style awards.”

Another approach may be to develop new targets that are easier to achieve in a recession. Substituting cash preservation or market share targets for simple measures of profit growth might be another.

“You have to have a conversation with shareholders, saying ‘we need to talk about what our priorities are’,” says Simon Garrett, a director in the UK executive reward group at Hay Group. “To simply say bonus levels are going to be the same with lower profit targets will get you a bloody nose.”

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