Do as I say, not as I do?
pharmafile | October 23, 2003 | Feature | Research and Development |Â Â management, pay, pharmaÂ
The new regulations requiring companies to put their remuneration committee reports to shareholder vote is starting to have a significant impact on the public acceptability of their total salary, bonus, benefits and share packages. Institutional shareholders are flexing their muscles and starting to put pressure on companies to curb some of their more obvious excesses.
A significant segment of public opinion and the Government in particular feel that this shareholder activism is long overdue. Indeed, one of the expressed driving forces behind the new regulations was a desire by the Government to encourage greater shareholder activism. The new regulations may be the first of many, if the Government's political objective of getting shareholders to control pay rather than it expressly legislating is not satisfied.
Shareholders get active
The new regulations do seem to be having some effect with the current round of AGMs seeing significant shareholder activism.
Shell had 23% of its shareholders voting against the company's remuneration policy for executive directors. Schroders had its Chief Executive's pay package challenged by shareholders with 14% voting against (7% abstained). GlaxoSmithKline has already announced changes to its remuneration committee and a review of its remuneration policies to try and head-off a shareholder revolt over executive pay. A number of other companies may also find themselves under attack, with the National Association of Pension Funds (NAPF) already flagging issues in advance of the AGMs.
For shareholders voting against the remuneration committee policy is a safe way of showing their displeasure with the board and their pay because the vote is advisory only and not binding on the company. It would be a far more serious matter if directors pay was conditional on the passing of this vote.
While it is currently inconceivable that the remuneration policy of a company will be rejected in its entirety by shareholders, these votes are significant and companies would be wise to take note of them.
This shareholder activism will obviously lead to a degree of friction with the management of companies. This is necessary and healthy while companies adjust to the new reality and ensures that the interests of directors are really aligned with those of shareholders.
However, where you are criticising someones remuneration the recipient can take it personally (for example, the Chief Executive of GSK, Jean-Pierre Garnier, went on the record to say that he found it upsetting), causing a high degree of tension, particularly if the person criticising is not perceived to be completely without criticism themselves. Indeed, some companies already feel that there is an element of hypocrisy from institutional shareholders, with a number of these shareholders demonstrating remuneration practices that their own corporate governance people would not support were they carried out by a company in which they had invested.
For example, questions are bound to be asked when some institutional shareholders are seen to have rewarded executives when shareholder value in their companies has been hammered:
- Aviva plc: the Chief Executive's pay has increased by 45% while shareholder value has decreased by 46% over 2002
- Legal & General: the Chief Executive was paid bonuses that more than doubled his total remuneration while shareholder value decreased by 34%
- Prudential: had a range of issues from the doubling of the Chairman's pay, payments to the Chief Executive exceeding £1 million and share incentives vesting for below median performance. Shareholder value during 2002 decreased by 44%
- Standard Life: the Chief Executive's pay increased by 26% while the value of the company decreased from £12.6 billion in 2000 to £3.2 billion
- Britannic: a pay award to the Executive Chairman of 8% while shareholder value has decreased by 56%.
Clearly, every company should be judged on its own particular circumstances and there may well be perfectly justifiable reasons for these payments. However, the perceptions of a number of executives of companies where these institutions are investors is that they are being criticised for remuneration practices that look remarkably similar to those carried out by the boards of some of their investors. For example, one of the hot topics raised by institutional shareholders and their representative bodies such as the Association of British Insurers (ABI) and NAPF in the current round of AGMs is bonuses and salary increases to executives despite the poor performance of the companies they manage.
No one is suggesting that two wrongs make a right. Nor that because some institutional shareholders may be paying substantial rewards for poor corporate performance that this should also be acceptable for the companies they invest in. However, while the UK may be a little retentive about the whole area of pay, the one thing that offends us all is where there is a perceived lack of fair play.
How is all this relevant to the average manager in a pharmaceutical company who does not sit on the executive board?
Some of these managers may even get a secret pleasure in seeing their board getting a good shoeing for pay packages far in excess of those they earn. While superficially this may be a satisfying approach to take it should be noted that pressure on board and senior executive compensation tends to have a knock-on effect on the pay and benefits package of all managers. In addition, a number of these managers will aspire to board positions themselves so it may not always be someone else whose remuneration is under the microscope.
A share of the spoils
One of the planks of the remuneration structure of a number of pharmaceutical companies has been share options. In the past there was considerable focus by UK pharma companies on the option packages offered by their US competitors to key employees – with these companies striving to provide competitive option packages.
This focus was shared by employees who saw large option grants as a way of making life-changing amounts of money. While the universal fall in the share prices of pharma companies internationally has resulted in a shift in emphasis by employees to cash elements of the compensation package and an appropriate damping down of wilder share-based expectations, share compensation is always going to be a significant part of employee compensation in this sector.
Share incentives – whether options or gifts of shares – provide employees with the potential to create personal wealth unlikely to be achieved merely through earning a salary and bonus. This desire of employees and mangers to 'share' in the potential jackpot of developing a new drug is still a powerful driving force in the pharma sector as a whole and particularly the biotech constituents.
There may now be a more realistic attitude from employees participating in these arrangements about their real value but it is inconceivable that share incentives will not still be an important part of their compensation package.
The parameters of these executive and management share incentive arrangements are normally set by the remuneration committee of the company. Institutional shareholders in the current climate are very keen to see performance measures attaching to all share incentives offered throughout the company and generally for there to be strong links between performance and pay. Therefore, remuneration committees are under pressure to ensure appropriate performance measures are attached to share incentives granted to executive directors.
In the past a number of companies have restricted the application of these corporate performance conditions to those share incentives granted to executive directors. Managers and employees have instead been granted share incentives where their provision was solely based on the lapse of time from the date of grant. In addition, a number of these time-based options granted to employees and managers by companies have adopted US-style step vesting.
This approach has often resulted in the terms and conditions attached to share incentives granted to middle management being more attractive than those granted to the board, albeit that the number of shares is substantially less.
The increasing pressure on remuneration committees to ensure that challenging performance conditions attached to share incentives granted to executive directors is likely to be reflected in the policy applying to all options granted to employees. This means that it is going to be less likely in the future for managers to receive options that have different terms to those granted to the executive directors on the board. The pressure on the number of shares that can be granted to employees by companies will make it difficult for managers to receive additional share grants to compensate for these less favourable terms. The share element of the compensation package provided to managers is the most likely element to be affected by recent shareholder activism.
It is easy to assume that all companies are being tarred with the same brush of executive excess if the newspapers are to be believed. However, it is still a very small minority of companies who have remuneration practices that have really got up the noses of shareholders. In addition, UK shareholders have always focused more on executive pay than pay throughout an organisation on the basis that if it is right at the top it is more likely to be right throughout.
It's a bonus!
If the current climate is going to put pressure on the size of share incentive awards granted to managers and the terms attached, how about bonuses?
One of the fundamental principals of designing any bonus plan is that participants have to be able to influence the performance requirements that have to be satisfied for a payment to be made to them. Therefore, it may appear that managers will only have to concern themselves with their particular area of responsibility and if they deliver their targets will be paid bonuses. However, there may be a number of factors underlying the assumptions behind these bonus plans that can be affected by the current shareholder debate.
Firstly, a number of bonus plans break down the overall corporate objectives into divisional and departmental objectives. If the board is under pressure to increase the corporate performance targets that they have to achieve to satisfy shareholders before bonuses are paid then this is going to flow down into more challenging divisional and departmental targets.
Secondly, the majority of managers are going to have some element of their bonus potential based on the overall corporate performance of the company. This will, therefore, expose an element of their total cash compensation to the external pressure to achieve greater levels of corporate performance.
One aspect of managers' remuneration packages, which is unlikely to be affected by the furore over executive pay, is salaries. Salaries are principally determined by the role occupied and the market for particular skills. Indeed there is some pressure to raise salary levels for people with marketable skills as the value of other parts of the compensation package are discounted.
In summary, managers are most likely to notice the impact of recent shareholder activism in their share incentive package. Bonuses may be affected as the corporate performance demanded by shareholders for bonus payments increases and with the campaign to ensure the link between performance and pay is reinforced. However, when this link breaks down it is an unfortunate fact of life that it is more likely to be at the senior levels of a company, than at the middle management level.
Like many things in life, pressure at the top results in increasing pressure below. Managers in all pharmacopoeias are not going to escape from hardening shareholder attitudes requiring companies to only pay for performance any more than their executive colleagues on the board. Good performing managers, however, should still expect to receive attractive remuneration packages, but they may have to work a little harder.
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