UK: Editorial - TIPs to reflect commercial reality.

UK: Editorial - TIPs to reflect commercial reality. - The latest way to reward the so-called fat cats is gathering pace.

Last Updated: 31 Aug 2010

The latest way to reward the so-called fat cats is gathering pace.

Long-Term Incentive Plans (LTIPs), based on the Total Shareholder Return provided by a company compared to that of its peer group, have become the predominant mechanism for creating incentive in the boardroom. And this time, it looks as though remuneration committees are on the right track. The elegance of the new breed of LTIPs lies in aligning the interests of a company's executive management precisely with the aims of the majority of its investors. The fund managers' target is to achieve returns higher than the market average and, under these schemes, that is what the management is rewarded for achieving.

The Management Today Total Shareholder Return tables, produced with the help of William M Mercer, provide the ranking for the FTSE-350 (see Who's Delivered the Goods?, p48). Depending on the size of a company, it may well be as appropriate to use a different comparator group, such as the FTSE-100 or the FTSE-SmallCap. Disappointingly, however, many schemes in place are based on a comparison with a smaller group, typically a company's individual industrial sector. This approach should be avoided for all but the most idiosyncratic types of business, such as companies in the oil sector. Comparisons with a hand-picked group of competitors reduce the alignment between the aims of investors and management, as the former can choose the sectors in which they wish to invest. It also introduces an element of opacity, through the creation of a measure that can be understood only by the keenest students of the scheme.

However structured, the new LTIPs attach huge importance to the stock market's perception of a company. This is no more than a reflection of reality. Honest investors will acknowledge that the degree to which they wish to support or reward a management correlates closely to the returns the management has provided. The stock market also offers one of the few measures of company performance that is both precise and objective. A beneficial side-effect of the schemes should be the reinforced incentive for management to communicate as clearly and as openly as possible with their investors.

Discomfort with this method of rewarding top management will be felt most keenly among proponents of stakeholding. Those who believe that looking after all stakeholders is best management practice - and ultimately in the best interests of shareholders - will be looking for signs that investors (and hence the stock market generally) are of a similar view. Those who go further, holding that companies are accountable to all their stakeholders, will need to acknowledge the gulf between their ideology and the current commercial realities which such investor-focused management incentives highlight.

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