After the Department for Business, Innovation and Skills (BIS) announced its consultation on executive pay last September, all kinds of research findings popped up, and by the time the Prime Minister’s blood starting boiling three claims had become incontrovertible fact: FTSE 100 executive directors last year awarded themselves a pay hike of 49 per cent; this was easy as they all sit on each other’s boards; and these increases bore no relation to performance.
Cracks appeared last month when MM&K and Manifest, the proxy rating agency, demonstrated the number of back-scratching cross-directorships was not just small but zero. Now all three pillars have fallen. The story was not just exaggerated, but completely untrue.
The 49 per cent figure came from Incomes Data Services (IDS) and was an average (technically a mean). But as my physics degree told me, the mean is not a good way of presenting a picture of skewed data. For a pattern of increases it is disastrous. I’ll illustrate this. Like IDS, Manifest collects remuneration data from annual reports. In early February they ran the numbers again – the latest company year-end included was October 2011 (IDS ran to March). This time the chief executive mean increase was 31 per cent – still outrageous, you may think. But take out the four highest increases, which had a mean between them of almost 500 per cent, and the mean drops to just 10 per cent. The median (the middle company) gives a much better picture – 10 per cent even if you leave the four companies with big rises in.
And in any case there was nothing rigged with the four outliers (Arm, Cairn Energy, Capita and Rio Tinto). They just had long-term plans vesting for the first time and a low previous year.
The Manifest 10 per cent figure, like the IDS figure, is of total remuneration realised. It covers salary, fixed benefits and annual bonus, and long-term incentives that have crystallised, that is, where the performance period is over or options are exercised. Salaries went up 2 per cent – the same as everyone else, if they were lucky. With their incentive packages on top, bosses have been doing better than the rest of us. But not enough to boil the blood.
But isn’t it true at least that the rises are unconnected with performance? Well no, actually. Everyone quotes the FTSE 100 index – it was 6,930 on 1 December 1999 – today it’s hovering around 5,900. How can top executives get such rises when the shareholder has lost out?
To begin with, such arguments forget about dividends. If we include these, the picture changes. We looked at total shareholder returns for the companies currently in the index since the beginning of 2003 – a total of eight years. We included companies that have been promoted to the index during that time, but excluded new entrants to the market. We ended looking at 66 companies. The mean total shareholder return was 15 per cent per annum, the median 13 per cent. Academics will rightly point out that there is a survivor bias here (lower performers are no longer in the index) and they might also call for a figure weighted by market capitalisation. But we wanted the figure to see how performance compared with the increase in total remuneration for this group of companies over the period (the median annualised increase in pay received over the eight years was 9 per cent). Note as well that the absolute return to shareholders was £713bn, whereas the total chief executives’ earnings (plus employer’s NI) came to £1.9bn, just 27 basis points on this return.
Finally, we looked at the increase in profits for the same group of companies. This shows a median annual increase of 19 per cent. So it is frankly wrong to say that pay increases are not justified by performance, for the median member of two thirds of the index anyway.
Since 69 per cent of the executive pay package is now performance-related, this result shouldn’t be surprising. The bandwagon needs to be stopped, and more real and rigorous research fed into the debate. The High Pay Centre could make a start by acknowledging our findings.
Damien Knight works with MM&K, the City-based independent remuneration consultancy.