UK: WEIGHING UP THE FAT CATS - Executive pay and company performance are under the spotlight once more in ...

UK: WEIGHING UP THE FAT CATS - Executive pay and company performance are under the spotlight once more in ... - WEIGHING UP THE FAT CATS - Executive pay and company performance are under the spotlight once more in the third MT/William Mercer Total Shareh

by ANTHONY HILTON.
Last Updated: 31 Aug 2010

WEIGHING UP THE FAT CATS - Executive pay and company performance are under the spotlight once more in the third MT/William Mercer Total Shareholder Return Table. Anthony Hilton analyses the findings and gives his verdict on the effectiveness of incentive plans.

It is now four years since Marks & Spencer's chairman Sir Richard Greenbury produced the report which bears his name and which led to the wholesale replacement of share incentive schemes with long-term incentive plans, or Ltips, long term being for this purpose a minimum of three years - a figure which has subsequently become the norm.

Justifying the Greenbury endorsement of rich rewards was the principle of performance. The incentive scheme would align the executive's interests with the shareholders', the executive then had to produce above average performance to earn his bonus.

If this was the theory, it has been confounded by reality. Every company cannot be above average, every share price cannot be in the top quartile and even the best of management cannot deliver performance to order. Business success is about luck as well as judgment, and there will always be winners and losers. Indeed one can be both. As Greenbury himself has discovered, calamity can come out of a clear blue sky.

So there are good reasons not to expect a total correlation between performance schemes and performance, between fat cats and fat profits. But the presence of one ought to increase the probability of the other, or there is little point in having it. Interestingly though, as the survey of recent winners and losers shown in these pages proves, there is little apparent connection between the two.

One of Britain's most successful fund managers remarked privately the other day that British executives no longer think they are in business to make widgets, nor to ensure their company is in a position to make widgets for years to come. Instead they now believe their prime purpose is to deliver enhanced value to shareholders, and they interpret this as having to deliver an ever-higher share price. This, he says, is a total change from 10 years ago.

This month we present a unique survey of how well our top companies are doing by that yardstick, with the publication of the third annual Management Today/William Mercer league table of the FTSE 350, ranked by total shareholder return (TSR). This is defined as the theoretical capital growth that would have been achieved by a shareholder over the three years to December 1998, assuming all dividends were reinvested.

Two things stand out immediately. The first is that the gulf between top and bottom could scarcely be more dramatic. The second is that only one FTSE-100 company, Misys, the computer software and systems supplier, makes it into the top 10.

The obvious moral is that small companies are more likely to deliver dramatic growth than big companies, and stock markets are more likely to get excited by their prospects, provided they can register on the institutional investors' radar. Provided a company has the management, and a gap in the market, it potentially can double and redouble. Giant companies simply cannot do that. Their market is too small for them to multiply endlessly.

So who's on top and who's on the bottom? Leading the field is Jarvis, the company whose core activity is track maintenance for Railtrack, a business that did not exist in the private sector five years ago. It has delivered the quite astonishing return of 3,366%, and that comes after a bad year in 1998 when its shares languished. It means that £100 invested in Jarvis three years ago would have grown to over £3,300 by the end of last year. On the bottom is De La Rue, whose business is making banknotes, but which certainly has not coined money for investors. One hundred pounds invested in De La Rue would, after three years, be worth only £33.

Apart from Jarvis, no one has managed even to clear the 1,000% hurdle, but while they are technically trailing in the leader's wake, they have, nevertheless, performed well.

There are big names down in the depths. Among the 40 or so keeping De la Rue company in having lost money for shareholders over the three years are BICC, Sears, BTR, Rexam, Inchcape, Pilkington, Lonrho, British Steel, Rank and United Biscuits. It reads like a litany of Britain's industrial past. There are also three FTSE-100 companies: the Telewest cable group, Hanson and Rio Tinto.

So what makes a winner? In these days of executive bonuses and long-term incentive plans, there ought to be a correlation between the best performing companies and the most lucrative executive incentive schemes. This after all is the intellectual and, indeed, the economic justification for incentive plans.

If only business were that simple. The reality is that there is no clear correlation. Five of the most highly rewarded FTSE company executives in Britain last year were Charles Brady of Amvescap at £4 million, Robert Wilson of Rio Tinto at almost £2 million, Peter Job of Reuters at £1.6 million, Sir Colin Southgate of EMI at £1 million and Sir Richard Evans of British Aerospace at £1.9 million. Of these, only Amvescap made it into the top 50 in the TSR lists, at 41. British Aerospace came close.

In contrast, Reuters, EMI and Rio Tinto were down among the dogs. The presence of an Ltip or otherwise seems to have made very little difference.

That said the executives concerned did rather well out of Ltips last year, although shareholder returns were poor over the three years. This suggests in part that the share price and shareholder return is an inadequate measure of management performance and competence - and Ltips don't necessarily guarantee performance.

This confirms most people's suspicions. It does not follow, simply because shares have fallen, that executives have performed badly. In some cases, it could have been a lot worse without their efforts.

'For an Ltip to be effective, performance should be measured against an appropriate peer group,' says Cliff Weight, principal at William M Mercer in London. 'The crucial question is what constitutes an appropriate peer group. Some companies, like EMI, use the FTSE 100, while others might prefer to use companies in their FTSE sector. But as companies become more global the way forward may be to measure performance relative to similar companies which are not necessarily UK based.'

Share price movement on its own, even over a three-year period, is arguably too simplistic. Ltips are almost always linked to share prices, and if one has doubts about the latter, then it makes one question the worth of the former. Fund managers have always preferred straightforward share options as an executive incentive, because they were often longer term and, unlike Ltips, simple to understand and assess.

Now they have even more reason for concern. All these incentives assume that investors buy shares only after some assessment of the company's performance. This is not the case with indexation, where fund managers use no discretion. They buy certain shares simply because they are in the index, and sell them when they are not. Thus a share that drops out of the Footsie, not through its own management's failings but because it was displaced by a larger company that got a listings here (as has happened with London listings of the big South African stocks, Anglo American, Old Mutual and SA Breweries), will go into free-fall as the trackers sell out.

Similarly, at the other end of the scale, no amount of management heroics has helped smaller quoted companies get the market to recognise their growing profits. Institutional investors today often regard anything with a market value of less than £800 million as too small to bother with.

This, at least in part, probably explains the skew in the league tables.

Taking the whole sample, the average TSR for the period is an impressive 101% - equivalent to an annual average return of 26%. The median TSR has increased from 44% last year to 62% this time, reflecting the markets' continued buoyancy. However the spread between the upper and lower quartiles has also increased, so the top 50% of companies have continued to improve on their performance while the bottom half have done less well.

There are 60 companies from the FTSE 100 in the top half of the rankings, and 40% of the companies that have been in the upper quartile in all three years are in the FTSE 100. This can be taken as confirming that the top blue-chip companies consistently outperform the smaller ones. But again, this may not all be down to management skill. If investors are in love with bigger companies, they will inevitably outperform in TSR terms.

This of course is hugely demotivating for management of the less favoured smaller companies. They have no control over share prices, and the movements do not accurately reflect executive performance, but their income and prospects for wealth are nevertheless hooked into the stock market. If such companies want to keep their most talented executives when share prices fall, they have to rebase their incentive schemes at the new lower stock levels. The crash of last autumn prompted this idea. Without it, executives would have defected from companies where they were hopelessly out of the money to companies where, as new arrivals, they could take advantage of the newly lowered stock prices.

Potentially, the stock market obsession of executives brings an even more serious distortion. Looking at the better-than-expected profit figures from American companies this spring, Warren Buffett, the celebrated American investor, published a scathing comment on his web site about managers whose desire to see a constantly improving share price prompts them to manipulate earnings: 'A significant and growing number of otherwise high-grade managers have come to the view that it is okay to manipulate earnings to satisfy what they believe are Wall Street's desires,' he wrote. 'Indeed, many CEOs think this kind of manipulation is not only OK but actually their duty.'

Mr Buffett's view, bluntly, is that investors are likely to get hurt if things do not calm down, because the scale of possible manipulation is already reaching astronomic proportions. Last year, for example, according to one estimate cited, write-downs and special charges reported by leading US companies in 1998 totalled $70 billion, yes, billion ( £44 billion).

All this scepticism still leaves the problem of how best to align executive and investor interests, but perhaps the clue lies in the table. The best performing company in our list, Jarvis, does not have an Ltip, but the chief executive does have a massive share stake in his own right. In the same vein, some of the most successful American companies insist that top executives use their own money - borrowing it, if necessary - to buy shares to the value of their annual income as a condition of holding office.

And on the same theme, River & Mercantile, one of our most successful small fund managers, has one specialist who only buys shares in companies where senior executives are major shareholders. He consistently outperforms.

So the moral seems clear. Too many incentive schemes follow the principle of 'heads, the management wins; tails, it doesn't lose'. Owning shares outright, rather than having them available on a promise, is the key - because only then do executives suffer on the downside. Only then do they look genuinely to the medium term.

FTSE 350 COMPANIES RANKED ACCORDING TO TSR 1996-1998

FTSE100 companies are marked *

1 JARVIS 3366%

2 CMG 811%

3 CAPITA GROUP 671%

4 BTG 659%

5 ADMIRAL 653%

6 SAGE GROUP (THE) 542%

7 RM 517%

8 MISYS* 497%

9 SEMA GROUP 441%

10 NESTOR HEALTHCARE 432%

11 STAGECOACH HDG.* 391%

12 INDE.INSURANCE GP 391%

13 SELECT APPT. HDG. 386%

14 PIZZAEXPRESS 376%

15 LOGICA 375%

16 BRIT. BORNEO OIL & GAS 351%

17 MANCHESTER UTD. 345%

18 JJB SPORTS 322%

19 COUNTRYWIDE 285%

20 SERCO GROUP 281%

21 COX INTL. HOLDINGS 247%

22 CATTLES 245%

23 LEGAL & GENERAL* 244%

24 AIRTOURS 241%

25 BODYCOTE INTL. 233%

26 VODAFONE GP.* 226%

27 LLOYDS TSB GP.* 215%

28 TAYLOR NELSON SOFRES 211%

29 PROVIDENT FINL. 208%

30 ASHTEAD GROUP 206%

31 GO-AHEAD GROUP 206%

32 BRIT. AEROSPACE* 206%

33 GEEST 205%

34 COMPASS GROUP* 203%

35 BANK OF SCOTLAND* 202%

36 KWIK-FIT HDG. 201%

37 HAYS* 201%

38 FIRST GROUP 196%

39 PSION 195%

40 AEGIS GROUP 187%

41 AMVESCAP* 184%

42 CORPORATE SVS. GP 180%

43 NATIONAL EXPRESS 177%

44 SMITHKLINE BHM.* 177%

45 RENTOKIL INITIAL* 174%

46 WPP GROUP* 167%

47 PRUDENTIAL CORP.* 161%

48 AMEC 161%

49 CLOSE BROTHERS 157%

50 COBHAM 155%

51 MAYFLOWER CORP. 154%

52 GLAXO WELLCOME* 153%

53 PEEL HOLDINGS 153%

54 ABBEY NATIONAL* 148%

55 EMAP* 148%

56 BARCLAYS* 146%

57 PERPETUAL 146%

58 ZENECA* 145%

59 WETHERSPOON (JD) 145%

60 KINGFISHER* 143%

61 NYCOMED AMERSHAM 141%

62 SIGNET GROUP 140%

63 AGGREGATE INDUSTRIES 138%

64 TBI 138%

65 TR EUROPEAN GROWTH 137%

66 NATIONAL GRID* 137%

67 MEGGITT 137%

68 DAILY MAIL 'A'* 134%

69 OCEAN GROUP 130%

70 GKN* 130%

71 THAMES WATER* 128%

72 PENNON GROUP 128%

73 BRITAX INTERNATIONAL 126%

74 ASDA GROUP* 122%

75 ROYAL BANK OF SCOTLAND* 121%

76 SHANKS & MCEWAN 120%

77 LIMIT 118%

78 BRITANNIC 114%

79 MAN (E D & F) GP. 111%

80 DIXONS GP.* 110%

81 CHARTER EUROPEAN 110%

82 NATWEST BANK* 108%

83 SENIOR ENGR. 107%

84 BG* 105%

85 UNILEVER (UK)* 104%

86 BOOTS* 103%

87 BP AMOCO* 103%

88 ROYAL & SUN ALL. IN.* 101%

89 SCOT. & SOUTHERN ENERGY* 101%

90 TESCO* 100%

91 FLEMING AMERICAN 100%

92 SETON SCHOLL HLTHCR. 100%

93 YORKSHIRE WATER 99%

94 CHELSFIELD 98%

95 CGU* 98%

96 ALLIANCE UNICHEM 98%

97 PILLAR PR. 97%

98 HAZLEWOOD FOODS 95%

99 F&C EUROTRUST 95%

100 CADBURY-SCHWEPPES* 94%

101 EDINBURGH US TRACKER TST. 92%

102 SCOTTISH POWER* 92%

103 SEVERN TRENT* 92%

104 STD. CHARTERED* 90%

105 MORRISON (WM) SPMKTS. 88%

106 ANGLIAN WATER 88%

107 WILSON BOWDEN 86%

108 GUARDIAN RYL. EX.* 86%

109 BRITISH TELECOM.* 86%

110 HSBC HOLDINGS* 85%

111 SCHRODERS* 85%

112 ASSD. BRIT. FOODS* 84%

113 INVESTORS CAP. GROWTH 83%

114 FLEMING CONT. EUROPE 83%

115 MERCURY EUR. PVTN. 83%

116 RIT CAPITAL PARTNERS 80%

117 RECKITT & COLMAN* 80%

118 UNITED ASSURANCE GROUP 79%

119 PEARSON* 78%

120 BTR SIEBE* 78%

121 DAVIS SER. GP. 78%

122 BBA GROUP 77%

123 LADBROKE GROUP* 77%

124 ELECTRA INV. TST. 77%

125 SHELL TRANSPORT & TRDG.* 76%

126 BERKELEY GROUP 75%

127 LIBERTY INTL. 75%

128 VIRIDIAN GROUP 75%

129 POWERGEN* 74%

130 LAND SECURITIES* 74%

131 CITY OF LONDON IT 74%

132 CABLE & WIRELESS* 74%

133 TRAVIS PERKINS 72%

134 LAING (JOHN) 'A' 72%

135 LONDON INTL. GP. 71%

136 DEVRO 70%

137 BASS* 70%

138 TAYLOR WOODROW 69%

139 SLOUGH ESTATES 69%

140 UNITED UTILITIES* 69%

141 TEMPLE BAR 69%

142 NEXT 69%

143 GRANADA GROUP* 68%

144 SCOTTISH MEDIA 68%

145 UNIGATE 68%

146 GOVETT STRATEGIC 67%

147 BTP 67%

148 SMITHS INDS.* 66%

149 MERCHANTS TRUST 66%

150 WHITBREAD* 66%

151 GENERAL ELEC.* 66%

152 LEX SERVICE 65%

153 ARRIVA 64%

154 ELECTROCOMP. 63%

155 SKYEPHARMA 63%

156 NATIONAL POWER* 62%

157 SCOTTISH INV. 62%

158 DUNEDIN INC. GROWTH 62%

159 TRINITY 61%

160 BRITISH LAND 61%

161 STANLEY LEISURE 60%

152 SCOTTISH MORTGAGE 59%

163 ANGLO & OVERSEAS 59%

164 ALLIANCE TRUST 58%

165 GT. PORTLAND EST. 58%

166 ARCADIA GROUP 58%

167 PEN. & ORNTL. DFD.* 58%

168 SECOND ALLIANCE 58%

169 EDINBURGH INV. TRUST 58%

170 SCOT. & NEWCASTLE* 57%

171 WITAN INV. CO. 57%

172 3I GROUP* 56%

173 BELLWAY 56%

174 BURFORD HDG. 56%

175 FIRST CHOICE HOLS. 55%

176 BARRATT DEVELOPMENTS 55%

177 JOHNSTON PRESS 54%

178 NORTHERN FOODS 53%

179 M&G GROUP (HDG.) 53%

180 UTD. NEWS & MEDIA* 53%

181 REDROW GP. 52%

182 DIAGEO* 52%

183 BROWN (N) GROUP 52%

184 CAPITAL RADIO 51%

185 MEPC 51%

186 MURRAY INCOME 51%

187 HYDER 51%

188 STAKIS 50%

189 SECURITIES TST. SCTL. 49%

190 SCOTTISH EASTERN 49%

191 ROLLS-ROYCE* 49%

192 BUNZL 48%

193 MONKS INV. TRUST 46%

194 FLEMING MERCANTILE 46%

195 FILTRONIC 45%

196 HAMMERSON 44%

197 TOMKINS 44%

198 ICELAND GROUP 44%

199 CHIROSCIENCE GP. 43%

200 JARDINE LLOYD THOMPSON 43%

201 BRIT. SKY BCAST.* 42%

202 SMITH (WH) GROUP 42%

203 BRITISH ASSETS 42%

204 SCOTTISH AMERICAN 41%

205 MURRAY INTL. 41%

206 BANKERS INV. TRUST 40%

207 BRIT. AMERICAN TOBACCO* 38%

208 BRADFORD PR. 38%

209 BEAZER GROUP 38%

210 CALEDONIA INVS. 38%

211 RACAL ELECTRONIC 37%

212 ENTERPRISE OIL 37%

213 LASMO 37%

214 MERSEY DOCKS 37%

215 FOREIGN & COLONIAL 37%

216 BAA* 36%

217 GT. UNVL. STORES* 36%

218 HENDERSON SMALLER COS. 35%

219 REED INTL.* 35%

220 FLEMING OVERSEAS 33%

221 MARKS & SPENCER* 33%

222 BRIXTON ESTATE 32%

223 GREENE KING 32%

224 CARLTON COMMS.* 31%

225 MIRROR GP. 31%

226 WILLIAMS 30%

228 IMI 30%

229 SAINSBURY (J)* 30%

230 BRAKE BROTHERS 29%

231 ST. IVES 27%

232 PERSIMMON 26%

233 BURMAH CASTROL 26%

234 BOWTHORPE 25%

235 HEWDEN-STUART 25%

236 REUTERS GP.* 25%

237 BRITISH AIRWAYS* 25%

238 TI GROUP 23%

239 LUCASVARITY* 23%

240 BLUE CIRCLE INDS. 23%

241 SAFEWAY (UK) 23%

242 IMP. CHM. INDS.* 22%

243 SWALLOW GROUP 21%

244 BOC GROUP* 21%

245 ALLIED DOMECQ* 20%

246 YULE CATTO 19%

247 BRITISH VITA 19%

248 ASSD. BRIT. PORTS 19%

249 MORGAN CRUCIBLE 17%

250 FKI 16%

251 BPB 15%

252 WASSALL 15%

253 TATE & LYLE 14%

254 TARMAC 13%

255 KALON GROUP 13%

256 TT GROUP 13%

257 MEYER INTL. 12%

258 WOLSELEY 12%

259 SPIRAX-SARCO 9%

260 MCKECHNIE 9%

261 WIMPEY (GEORGE) 9%

262 POWELL DUFFRYN 8%

263 NFC 7%

264 HALMA 7%

265 WEIR GROUP 7%

266 CRODA INTL. 6%

267 RUGBY GROUP 5%

268 VICKERS 4%

269 SMITH & NEPHEW 1%

270 ELEMENTIS 0%

271 FIRST LEISURE 0%

272 EMI GROUP* 0%

273 LAPORTE -3%

274 RIO TINTO (REG)* -4%

275 RMC GROUP -4%

276 PENTLAND GROUP -4%

277 HILLSDOWN HDG. -4%

278 GREENALLS GP. -4%

279 HANSON* -6%

280 JOHNSON MATTHEY -6%

281 MARLEY -7%

282 CELLTECH -9%

283 MONUMENT OIL & GAS -10%

284 STOREHOUSE -10%

285 UNITED BISCUITS -12%

286 TEMPLETON EMRG. MKT. -14%

287 PIC INTERNATIONAL GROUP -15%

288 SCAPA GROUP -16%

289 RANK GROUP -16%

290 COOKSON GROUP -19%

291 CARADON -19%

292 GLYNWED -22%

293 HIGHLAND DISTILLERS -22%

294 ARJO WIGGINS APL. -23%

295 HEPWORTH -23%

296 BRITISH STEEL -24%

297 TELEWEST COMMS.* -27%

298 CHARTER -27%

299 SMITH (DAVID S) -33%

300 ENG. CHINA CLAYS -33%

301 LONRHO -34%

302 MEDEVA -37%

303 PILKINGTON -37%

304 INCHCAPE -38%

305 REXAM -38%

306 BTR -45%

307 PREMIER FARNELL -48%

308 SEARS -51%

309 BICC -55%

310 EUROTUNNEL UNITS -62%

311 DE LA RUE -67%

WHAT IS THE INCENTIVE?

A COMPARISON OF THE TOP FTSE 100 PERFORMERS WITH THOSE AT THE BOTTOM

SHOWS THE PRESENCE OR OTHERWISE OF AN LTIP MAKES VERY LITTLE DIFFERENCE

TO AN EXECUTIVE'S PERFORMANCE

THE FOOTSIE LEADERS

CEO Salary Bonus LTIP* Total

Compensation

(pounds) (pounds) (pounds) (pounds)

KEVIN LOMAX,

MISYS 285,717 329,287 193,228 808,232

MIKE KINSKI,

STAGECOACH 372,000 250,000 80,069 630,069

DAVID PROSSER,

LEGAL & GENERAL 440,000 400,000 361,215 1,201,215

CHRIS GENT,

VODAFONE 587,000 0 3,246,985 3,833,985

PETER ELLWOOD,

LLOYDS TSB 475,000 199,000 940,797 1,614,797

SIR DICK EVANS,

BRITISH AEROSPACE 501,000 175,000 1,194,250 1,870,250

FRANCIS MACKAY,

COMPASS GROUP 425,000 138,000 1,418,654 1,981,654

PETER BURT,

BANK OF SCOTLAND 277,000 90,000 785,382 1,152,382

SIR RONNIE FROST,

HAYS 250,000 94,000 123,981 467,981

CHARLES BRADY,

AMVESCAP 335,000 2,412,000 1,333,000 4,080,000

THE FOOTSIE LAGGARDS

CEO Salary Bonus LTIP* Total

Compensation

(pounds) (pounds) (pounds) (pounds)

CHRISTOPHER COLLINS,

HANSON 310,000 155,000 544,223 1,009,223

ROBERT WILSON,

RIO TINTO 669,000 144,000 1,179,548 1,992,548

SIR COLIN SOUTHGATE,

EMI GROUP 543,300 105,500 361,600 1,010,400

TONY HALES,

ALLIED DOMECQ 460,000 165,000 732,065 1,357,065

DANNY ROSENKRANZ,

THE BOC GROUP 473,000 290,000 0 763,000

CHARLES MILLER SMITH,

ICI 550,000 0 78,439 700,439

BOB AYLING,

BRITISH AIRWAYS 450,000 0 0 450,000

PETER JOB,

REUTERS 522,000 255,000 815,938 1,592,938

* LTIPs is the sum of stock options and restricted shares.

Stock options: In-the-Money value of options granted in 1996 to 1998,

using 31 Dec 1998 share price.

Restricted Shares: Face value of all shares granted in 1996 to 1998,

using 31 Dec 1998 share price.

Both Telewest Commications and LucasVarity changed CEO during the

period covered and are therefore not included in The Footsie Laggards

TOP FIVE CLIMBERS

Company Rank '98 Rank '96 Change

1 TBI 64 319 +265

2 BG 84 312 +228

3 KINGFISHER 60 272 +212

4 SCOT. & SOUTH. ENERGY 89 278 +189

5 SENIOR ENERGY 83 260 +177

TOP FIVE FALLERS

Company Rank '98 Rank '96 Change

1 CELLTECH 282 31 -251

2 BRITISH STEEL 296 57 -239

3 DAVID S SMITH 299 70 -229

4 EMI GROUP 272 45 -227

5 SPIRAX-SARCO 259 34 -225

CALCULATING TSR

TSR is the theoretical capital growth that would have been achieved by a shareholder over a three-year period, assuming all dividends were reinvested.

This methodology compares the average share price for the year preceding the three-year period with that of the final year. The calculations are fully adjusted for rights issues and other capital changes.

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