BROAD sections of the media are reporting misleading statistics on recent increases in directors’ pay. According to figures released by Incomes Data Services (IDS), the average salary rise among FTSE 100 directors was a huge 27 per cent over the last year.
But highlighting 27 per cent misrepresents the facts. It follows on the reporting of similar figures last year, when IDS announced that pay rose by 49 per cent. Back then, a more realistic representation of the change was a 10 per cent increase. So what is going wrong?
The first issue is focusing on the “average” change. An average is not a good way of presenting a picture of skewed data. If just five companies on the FTSE 100 offer their directors a large increase in salary, the overall average change will inevitably be distorted.
A better way of looking at the figures is to consider a median adjustment – the mid-point in the data. This removes the skew of a few very high (or very low) changes, and gives us a more accurate figure of what is going on. According to the IDS’s report, this year’s median increase was just 10 per cent.
Pay for chief executives is also highly variable, so remuneration can change drastically from one year to the next. A large increase could be because of excellent performance. In many cases, it is also a case of timing.
It is now normal practice for directors to be given a long-term incentive plan (LTIP), which measures performance against the company’s share price over three years. A large part of the pay received this year may therefore be related to the successful performance of the company over that three year period.
Three years after the award of a LTIP, performance will be assessed. In roughly half the cases, the performance target will not be achieved. In about one quarter it will be fully met. And in the other cases only part of the award will be handed out.
A simple example will explain what is happening and how the statistics become biased. Suppose in the first year, a chief executive’s payout is £1m salary, a £2m bonus and nothing from the LTIP – a total of £3m. In the second year, the payout is a £1m salary, a £2m bonus, and a full payout of the LTIP. If the company’s share price triples in the performance period, the LTIP payout would be £6m. This would mean total pay received of £9m – a 200 per cent increase on the previous year. In the third year, pay is £1m salary, a £2m bonus and nothing from the LTIP – a total of £3m.
If you just take the year-on-year figure, inevitably you’ll see large changes as share prices move up or down from the date of the LTIP award. But a large payout will likely reflect a company’s good performance over the time period. And the same reward could easily disappear the next year.
There are, therefore, better ways of understanding IDS’s figures on director-level pay. One more useful average statistic is to compare the average total remuneration this year with the average the preceding year. Our MM&K/Manifest Survey calculates this average, which was 12 per cent.
Cliff Weight is an executive compensation consultant at MM&K and a member of the advisory board of the High Pay Centre. His forthcoming book on directors’ remuneration is published on 17 December.