Motivation vs Greed
"Greed is good", said Gordon Gekko, played by Michael Douglas in the iconic movie Wall Street. But in the real world, according to Vince Cable, ridiculous levels of remuneration are going unchallenged as the norm. Is Vince right, and if so, where should businesses draw the line?
A report recently published by the High Pay Commission (an independent body funded by the Rowntree Trust) found that for executives in the largest companies, bonuses over the last decade have almost doubled, from 48% of salary to 90% of salary. Meanwhile, the salaries themselves have gone up by no less than 63%. For smaller companies, the increases have been lower but still substantial. The Commission goes on to say, based on the evidence, that salary growth bears no relation to either market capitalisation, earnings per share or pre-tax profit and that there is no or little relation between the total earnings trend and market capitalisation. A particularly interesting feature of the study is that (again for the largest companies) the proportion offering share based LTIPs has increased from 71.4% to 87.8%. LTIPs normally involve the award of company shares after a period of years. Over the same period, the proportion of larger companies offering share option schemes has declined by almost two thirds, from 90.9% to 32.6%.
Flight from risk
LTIPs and options both involve shares, but here is the crucial difference: LTIPs will always have some value unless the company fails, whereas share options normally have value only if the share price goes up. Of course, it is always possible for a company to award options with a discounted or nil cost exercise price, but since this is effectively a gift of value, nil-cost options are really LTIPs in disguise.
Over the last decade, therefore, not only have total benefit levels risen dramatically, but they have also been de-risked by a switch from options to LTIPs.
This problem is less acute in smaller companies since the managers may also be significant shareholders and therefore the interests of shareholders and executives are more aligned. But, at the RM2 Partnership, we have noticed a growth in the use of LTIPs among smaller companies also, often with minimal performance requirements, and we would regard this as a negative development.
Bring back options
Our recommendation is that wherever possible, companies should offer options with an exercise price set at current market levels. For most smaller companies employing fewer than 250 employees and with less than £30m of gross assets, share options may also be more tax efficient if the company qualifies for the government backed Enterprise Management Incentive (EMI), since gains will be within the Capital Gains Tax (CGT) regime and not subject to income tax and NICs. Larger companies can make use of the Company Share Option Plan (CSOP), another government backed scheme which is also tax-efficient. However this scheme is now showing its age and is limited to options over shares with a maximum value of £30,000 per employee a limit which has not changed for many years and is too low for many companies.
Companies for which these schemes are unsuitable either by virtue of company size or the level of reward to be offered face a difficult choice when it comes to the design of their equity incentives. There are no tax-efficient schemes available to them. Remuneration Committees have therefore increasingly fallen back on LTIPS, which also have no tax advantages, but at least carry a more certain prospect of reward than share options.
We believe that the government should look closely at these developments and consider the introduction of a tax-advantaged scheme that all trading companies can use, to help restore the connection between reward and performance.
The Association of British Insurers has recently published its latest guidelines on executive remuneration. Included for the first time is a principle that companies should grant levels of reward that are not more than necessary. This is of course nothing but the truth, but the fact that the ABI feels it necessary to enshrine this concept as one of their remuneration principles is perhaps a reflection of what has gone wrong with our remuneration culture.
If you would like to discuss any of the issues mentioned in this article, please contact the RM2 Partnership on 020 8949 5522 and speak to a member of our team.