Financial Times: Extras play role in ratcheting up remuneration as executive pay packages increase by 11%

Investors leafing through the pile of remuneration reports and voting forms ahead of annual meetings will find that basic pay packets haven't grown nearly as much as bonus and incentive schemes.

It is still early in the season but already some institutional shareholders have spotted a trend of “ratcheting” up overall executive remuneration where the double-digit rises are from extras rather than salary.

Independent Remuneration Solutions, a pay consultancy, says that base salaries of chief executives of the top-10 FTSE 100 companies has risen by about 8 per cent.

But the total value of their remuneration, including bonuses as well as the expected value of share option awards and long-term incentive plans, increased by about 11 per cent in 2005.

William Claxton-Smith, a director of Insight, the investment arm of HBOS, says: “We have no issue with pay for high performance but we are worried by the general creep up in base pay from which all other pay is calculated.”

Some shareholders say the rises are more noticeable among FTSE 350 companies than Aim companies. Others note big increases in sectors such as pharmaceuticals, banks and media, which historically pay for talent.

Anita Skipper, head of corporate governance at Morley Fund Management, first warned in January that the trend in remuneration was of growing concern.

“We are concerned about ratcheting pay where it isn't matched with better performance,” she says.

Exceptional pay should only makes sense for exceptional performance, says Morley.

Some substantially higher pay-outs have raised raised eyebrows.

Amvescap, the Anglo-American fund management group, last month revealed it paid Charles Brady, its founder who is stepping down as chairman, a $9m bonus for leading the group through “a difficult period”, fending off a bid approach and finding a successor.

Amvescap has suffered from years of fund outflows and was the subject of an investigation in the US into alleged irregular trading practices three years ago.

Marty Flanagan, the new chief executive, received $14.2m, making him Amvescap's highest paid director. This included $11.75m in compensation for incentives foregone when he left Franklin Templeton.

Rrev, the voting arm of the National Association of Pension Funds, says the justification was “inadequate” highlighting Mr Flanagan's four-year initial contract that flouts UK best practice. Pirc, the pension and investment research consultancy, recommends a vote against the report arguing that Mr Brady “should not be additionally rewarded for fulfilling their job description”.

Pirc is also recommending shareholders oppose Pearson's remuneration report. Performance conditions on long-term incentive plans at the media group, owner of the Financial Times, are insufficiently challenging, says Pirc, and bonuses are included as part of compensation on contract termination.

Royal Dutch Shell drew comment after lifting its chief executive's salary by 19 per cent last year to €1.53m (£1.05m) last year. Jeroen van der Veer's total pay package including a bonus increased by 32 per cent from £1.8m in 2004 to £2.4m.

However, Shell responds that the total pay package is the result of high performance from the group and that the jump in base pay reflects two years' worth of increases from when Mr van der Veer was made chief executive in October 2004.

Observers note that Shell directors' pay generally lags the sector and increases bring directors' more into line with their peers.

But shareholders point out that these rises push up the benchmark, which in turn feeds into spiralling salaries. An example of how pay can ratchet up in this way can be found among smaller oil companies, says John Lee, managing partner at New Bridge Street Consultants, the pay consultants. Rising oil prices have lifted a number of the smaller oil companies into the FTSE 250, where their pay structures looked mean compared with their new peers. This prompted their boards to respond with pay rises.

New Bridge Street estimates that average increases in base executive salaries were still an unremarkable 6 per cent last year.

Shareholders counter that this is higher than wage inflation, estimated at 4 per cent across the economy.

The Association of British Insurers in December warned of the “detrimental consequences” if the trend continued. “It can't go on for ever without something snapping,” said Peter Montagnon, director of investment affairs.

Remuneration has become such a sensitive issue between investors and companies that many companies canvass their top shareholders for approval on pay plans before the annual vote on remuneration reports.

Vodafone is consulting its major shareholders on its policy for next year. The mobile operator wrote to leading shareholders last week proposing changes to its pay policy for senior executives. It requested feedback by May 23.

Prudential, the insurer, has consulted shareholders twice to avoid any repeat of the row that damaged relations previously.

Prudential is hoping to win the backing of shareholders for a long-term pay plan that could see Mark Tucker, its chief executive, earn £3.57m for his performance this year.

Mr Tucker's basic salary is £840,000 this year. He could also earn up to 125 per cent of his salary in bonus, an increase on the 110 per cent in the previous plan. He could also earn up to 200 per cent of salary under the group's incentive plan.

But as part of the new plan, Mr Tucker and Michael McLintock, chief executive of M&G, will be required to hold shares worth two-times their basic salary. Other executive directors were required to hold shares equivalent to their basic salary.

One Prudential shareholder said: “I think they are doing what they can to make sure that they have investors on side.”

Directors and shareholders spend more and more time working on remuneration.

Justifiably, many companies have had to lift rewards for executives to retain talent, particularly finance directors, to distract from the lures of overseas rivals and private equity firms.

Long-term incentive plans (LTIPs) are increasing as a percentage of salary. Maximum awards – if executives beat all their targets – may be 150 per cent of salaries and more. This marks a big shift from two-years ago when the maximum was rarely above 100 per cent, says New Bridge Street.

But there remain concerns about the effect of incentive plans which are measured against basic salaries.

Five years ago maximum bonus awards might have represented 30 per cent of salaries. For the past couple of years FTSE 100 directors have been able to earn bonuses worth the equivalent of 120 per cent of their salaries. This year the median maximum bonus pay-out hit 100 per cent for FTSE 250 directors also. This trend is causing investors to push for greater disclosure.

Too often, say investors, companies do not disclose the performance criteria for individual bonuses paid to directors on the basis that targets are price sensitive.

Shareholder attention is also turning increasingly to pensions as companies continue to boost contributions to executive pensions.

Investors acknowledge remuneration structures have come a long way, but say there is still considerable room for improvement.