Hard to Get

As the challenges facing executives grow, their compensation shrinks.

Jason Karaian
- CFO Europe Magazine

April 2, 2009

Last month, Jan Hommen made a "moral appeal" to senior staff at his
firm to pay back the bonuses they received a few weeks earlier, such
was the public anger about payouts at ING, the Dutch bank that's been
propped up by a government bailout. The tipping point, it turns out,
was a 100,000-share award—worth up to €1.3m—to incoming CFO, Patrick
Flynn. It was difficult for Hommen, ING's supervisory board chairman,
to justify this and previous payouts amid widespread scorn.

There is no doubt that executive pay at banks will change
dramatically, given the state aid they have received and the blame for
the financial crisis heaped upon them. That said, "there is bound to be
a certain amount of seepage into the broader executive scene," says
Calvin Jackson, a senior consultant at Watson Wyatt. Though the changes
may not be as radical, non-financial companies will still find it
difficult to justify previous pay practices.

Take Volvo. In February, the Swedish truckmaker said that according
to recent benchmarks, its executives were underpaid in relation to
competitors. In response, the company wanted to raise the ceiling for
performance-based pay as a share of salary and boost the amount of
shares in its long-term incentive plan. In the wake of a large
fourth-quarter loss and more than 16,000 layoffs, the backlash was
swift, with Sweden's prime minister, Fredrik Reinfeldt, calling the
actions "offensive." Within a week, the company was forced to rescind
the proposal.

Not the only company experiencing losses and layoffs, Volvo serves
as a useful example for firms struggling to retain, motivate and reward
executives in a hostile environment. "When I read the newspapers, it
seems that executive pay is responsible for the entire financial
crisis," says Xavier Baeten, manager of the Executive Remuneration
Research Centre at the Vlerick Leuven Gent Management School in
Belgium. Opinions vary widely on what the ideal executive pay package
should include, with greater consensus about what should not be
allowed. (See "Seven deadly sins" at the end of this article.)

Just rewards
For its part, the European Commission urged
member states in late March to address "excessive" executive
remuneration. All members should mandate disclosure of pay policies and
individual directors' pay, the commission asserted, adding that only
two-thirds do today. Executives should have "no involvement whatsoever"
in setting pay, severance should be restricted to two years' worth of
salary and benchmarks should take account of pay variations both inside
and outside a company. As always, however, the follow-through on these
proposals will lie with each member state.

To date, Germany has gone further than most. A draft bill expected
to be passed by this summer requires listed companies to have, among
other things, executive packages with long-term incentives of at least
four years and charges the entire supervisory board—not just a
sub-committee—with responsibility for setting pay policies. Executive
compensation must also be "adequate" and "customary" in relation to
individual, corporate and industry performance. Given the bill's vague
language and uncertain enforceability, it is "more or less a threat,"
notes Kerstin Schmidt, a partner at Lovells in Dusseldorf. The "vivid"
expression of anger by the general public is more likely to drive
change to pay policies, she adds.

Whatever the starting point, experts predict a range of reactions as
companies rewrite the traditional rules. "We are in completely
uncharted territory," says Mary Robertson, an interim HR executive and
director of Reward Matters, a consultancy. "A year ago, I was doing a
lot of work on flexible benefits and elaborate incentive schemes," she
says. Today, with cash scarce and bonuses taboo, she is "helping
companies spend the money they have better." This often includes making
incentive plans simpler.

For most firms, the simplest form of pay—base salary—is likely to be
frozen for at least this year. However, the share of fixed pay in
remuneration packages—around 30% at most large European firms—is likely
to grow as variable pay shrinks. (See chart at the end of this
article.) With previous performance targets now almost impossible to
achieve, lower hurdles will be needed to ensure executives are
realistically motivated. "Shareholders will be willing to accept lower
targets for future rewards but the quid pro quo might be a smaller
reward," says Rob Burdett, a principal at Hewitt New Bridge Street. Of
course, in the current job market, many executives may be happy simply
to remain employed. "A lot of executives would do their same jobs for
30% less," reckons Baeten of Vlerick.

The metrics for measuring performance-based pay are also likely to
change, says Baeten. "You need, at maximum, five performance measures,"
he says, asserting that this won't affect the effectiveness of previous
plans. "Going for simplicity can, in a way, make decisions more complex
because CFOs will need to decide what performance measures really count
for their companies," he adds.

What might these metrics include? Governance and compliance measures
may find their way into incentives as companies aim to bolster risk
management processes. And rather than ubiquitous EPS and TSR-based
metrics, Peter Boreham, a director at Hay Group, expects "cash, cost
control and customer" measures to rise in importance. This means that
the trend towards uniformity in pay packages could reverse as
company-specific measures gain prominence. "This is a time when the
market has never been less relevant to remuneration committee
decisions," adds Eric Duffelen, a principal at Towers Perrin.

For more information on European Exec Comp.

Posted by Dan Walter

Performensation: Equity Compensation for High Performance Companies.