course Charting your own Re-evaluating reward Top Executive Compensation in Europe

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1 Charting your own course Re-evaluating reward Top Executive Compensation in 13 There is now clear evidence across that the continent is on the road to recovery. This creates a serious challenge for corporate boards: how can companies keep a lid on pay rises for their critical people while attracting and retaining the talent needed to capitalise on market opportunities? As pressure builds in the reward system we expect to see increasingly diverse pay practices and more people moving between companies. The challenge for organisations is to design reward that is truly fit for purpose. Only by focusing on their own strategic goals and establishing the business case for reward can companies navigate a route to take advantage of talent and growth. /executivereward

2 Key trends Carl Sjöström, Regional director of reward services for Hay Group, discusses the key trends and developments in an executive pay over the past 1 months. This summary is based on the findings as detailed in Hay Group s study of Top executive compensation in 13. Top Executive Compensation in 13 is the most comprehensive study of an executive reward available. It analyses compensation data from 33 an FT 5 companies, providing market context and thorough analysis to help firms make informed decisions. The study covers the top team accountable for group performance, typically the chief executive and the rest of the management board or the executive committee. The report is based on the latest available data from 13 and all data are provided in Euros, calculated according to the average daily exchange rate over 1. To purchase the full study, or for more information, please speak to your local Hay Group contact or your request to: execrewardeurope@haygroup.com. The shadows of regulation Regulation is stabilising but continues to influence reward. Five years on from when the Lehman Brothers demise heralded the worst financial crisis since The Great Depression, commentators are beginning to speak in optimistic terms about the future. For many large an companies, the consequences of the credit crunch for executive reward were unprecedented; an explosion of regulatory demand fuelled by public outcry and political opportunism. In the past year alone, has raised the tax on equity-based incentives, has revised its code on corporate governance, the United Kingdom has introduced a binding vote on policy as well as new disclosure requirements, and is coping with the aftermath of the Minder initiative vote. The results of this referendum will mean that not only catches up with the tightened regulatory controls of other regions, but overtakes the rest of the an field in the regulation stakes. However, as our latest study shows, the regulatory environment is beginning to stabilise even the financial services sector has become decidedly calmer and this situation is likely to realise further improvement once the consequences of the latest instalment of the an capital requirements directive ( CRD IV ) have been accounted for. Yet regulatory changes are by no means complete. Several an countries are heading towards, or just emerging from, general elections and with the arguments around social inequality, executive reward is a tempting target for attack. Furthermore, a greater accent is being placed on the social divide in the form of diversity our study s sample contains less than 8 per cent female executives, a figure that would have been far lower had it not been for the Nordic countries where the percentage of female executives ranges from 15 to 6 per cent. Most countries in still see relatively little interaction between investors and companies typically to the cost of effective incentive plans.

3 7 Top executive compensation in 13 Design demands attention Companies are under pressure to design simpler incentive plans. Investors are beginning to understand that detailed corporate governance codes, combined with regulatory requirements, have led to a raft of complex remuneration designs that need to be fully understood before they are voted on. As a result, there is a trend towards pressuring companies to adopt simpler designs, a move that is being met with little resistance from incentive plan participants. However, there are further implications; companies will need to understand how to navigate not only the design itself, but also the nuances of managing investor relations. We ve found that most countries in still see relatively little interaction between investors and companies typically to the cost of effective incentive plans. Until now, most of the attention in the marketplace in matters of reward has been focused on the disclosure of executive pay and design of incentives. However, executive pension plans are ever-present as one of the most costly, complex and political areas of executive reward. We expect increased attention to be focused on these pension plans in many countries, especially as tax legislation becomes less generous. The fact remains that there are still many rich legacy plans in place throughout, but very few companies are offering them up to new hires. Hence, the benchmarking of pension plans needs more accurate examination when seeking interpretation, as what the market pays does not necessarily reflect what the market offers. Other legacy issues that are likely to gain more attention in the near term are contractual arrangements, termination payments and the effect on reward when there is a capital event, such as a change in control. Recent scandals have been all about small details with large effects and companies should ensure that their boards are aware of remuneration risks in the same way as with other strategic or operational risks. Taking action on talent Talent-related tensions mount between investors and business leaders. Aside from pension solutions, contrary to a decade ago, there is barely any appetite for designing reward solutions from a tax planning perspective, nor is there a desire to confront public opinion on the matter of executive pay with business logic and financial reasoning. However, we are concerned that as the green shoots of economic recovery are beginning to emerge, companies will struggle to attract the talent needed to capitalise on their improving fortunes. Many investors are recognising this emerging problem as the employment market for top senior talent picks up, but the majority of companies remain unwilling to discuss alternative reward solutions and would rather simply conform to set guidelines, codes and regulations to avoid any confrontation. We expect shareholders to challenge companies far more on this reluctance to take action, with the result being increased conflict between different investor groups. Investors are diverse in their goals, timelines and outlooks and as more long-term investors begin to question tick-box approaches to governance, companies will need to address the discrepancies between what is desired and what needs to happen in practice through better communications and clearer business arguments. Courting compliance and change Companies are adopting a holistic approach to their reward strategies. The biggest technical challenge for companies continues to be an exaggerated focus on compliance at the expense of strategic reward. However, increasingly, companies that have managed to avoid sacrificing one for the other are coming to the realisation that benchmarking against market data is not the only important reference point. Understanding how a reward strategy compares in the market requires assessment of the context of the reward package: how it aligns to a company s strategy, structure and culture, as well as giving due consideration to the risk a Euro of value delivered in the future is not necessarily perceived to be worth a Euro today. If organisations aim to take advantage of the predicted upturn in the market, they should not just follow the crowd in designing reward packages but establish the business case for reward and how to ensure its success. 1 Hay Group. All rights reserved

4 9 Top executive compensation in 13 Another year of cautious salary increases The cautious approach to pay continues. Figure 1: Median year-on-year per cent growth in base salary (same job, same incumbent) Figure : 16 Country median base salary as percentage of an median The trend for low salary increases established over the past few years continued for 13, where we saw a median increase of.5 per cent. This increase compares to. and.6 per cent increases in 1 and 11 respectively and is aligned with the an inflation rate of.6 per cent 1. Clearly, an corporate boards are continuing to make sure that executive base pay does not stand out against other economic indicators. There are some clear geographic differences, although far less pronounced than in previous years.,, and, for example, all saw a zero change in salary at the median with the most notable movement being in the Netherlands, where the median salary increase was 3. per cent. However, this was not enough to move the Dutch median up from among the lowest of the larger economies. The trend for low salary increases established over the past few years continued for 13, where we saw a median increase of per cent. 1 Source - Eurostat..5 It should be noted that the sample represents the companies from these countries that are among the an FT 5 Index constituents. For a broader look at executive reward in each country, please see the relevant local Hay Group executive reward study. 13 Hay Group. All rights reserved

5 11 Top executive compensation in 13 Short-term incentives Short-term incentive payments made for 1/13 performance were marginally more positive, with 8 per cent of our sample receiving an increased payment and 5 per cent registering a decrease. In 11/1, per cent of the sample received an increase and 6 per cent a decrease. At the median, there was no change in target bonus opportunity and actual payouts fell with about one in ten executives receiving no short-term incentive payment for the year. Figure 3: Short-term incentive payouts against targets Deferred bonuses The rise of the deferred bonus, which was promoted through regulatory changes to reward in the financial services sector following the financial crisis, now seems to have plateaued. Just over 1 per cent of the companies surveyed this year have a compulsory deferral period for part of their bonus payouts. 1/13 11/1 11/1 11/1 1/11 1/11 5% 8% 6% 6% 6% % % % 3% 3% 3% 6% 6% 6% Table 1: of companies with compulsory bonus deferral % 3% 33% 5% 19% 7% 1% 1% 1% 8% 8% 8% Increased Same as previous year Decreased Increased Increased Increased Same as previous Same as year Same previous as previous year year Decreased Decreased Decreased Increased Increased Increased Same as previous Same as Same year previous as previous year year Decreased Decreased Decreased The rise of the deferred bonus now seems to have plateaued at just over per cent of companies Hay Group. All rights reserved

6 13 Top executive compensation in 13 Total cash Although levels of total cash, the sum of fixed salaries and short-term incentives, have begun to move up again at a median year-on-year increase of. per cent, they are not out-pacing salary movements. Last year, the total cash median increase was.8 per cent and none of the major countries in the study showed a median total cash increase of more than 1 per cent. However, this year the picture is far more mixed. In, and median increases were above 3 per cent, outpacing GDP growth, whilst in and the United Kingdom the median total cash dropped. Figure 5: Country median total cash increases versus gross domestic product (GDP) and inflation 8 6 Figure : Country median total cash as per cent of an median Sources: Hay Group, Eurostat Growth GDP Inflation The proportion of companies with a long-term incentive plan has increased from per cent of the sample to per cent Hay Group. All rights reserved

7 15 Top executive compensation in 1 Long-term incentives The picture is largely unchanged from 1 in terms of the types of long-term incentives that large an corporates have in place. There are, however, two notable differences this year. First, the proportion of companies with a long-term incentive plan has increased from 78 per cent to 8 per cent. Second, as a result of this increased prevalence and a median growth in expected award value of 8.5 per cent, long-term incentives have become an even more important part of the executive reward mix. Total direct compensation Long-term incentive plans as a proportion of total direct compensation is at the median 3 per cent. This is a significant change compared with past practice. As figure 6 shows, the an average has been fairly consistent in the past, but today there is a clear shift towards more variability; in particular, more long-term incentives are being included in the total package. With the increases in long-term incentive awards, the total direct compensation median increase was 6.9 per cent for. Table : Long-term incentive plan prevalence in Figure 6: Make-up of target total direct compensation Stock option and phantom option plans Performance shares/units Restricted shares/units Long-term cash plan 3% 5% 9% 15% 16% No long-term incentives % 8% 8% % % 9% 9% % 9% % % % % 3% 3% 39% 39% 39% 8% 8% 8% 7% 7% 7% 7% 7% 7% Base Base salary salary Base salary Target Target bonus Target bonus bonus Long-term Long-term Long-term incentive incentive incentive Base Base salary salary Base salary Target Target bonus Target bonus bonus Long-term Long-term Long-term incentive incentive incentive Base Base salary salary Base salary Target Target bonus Target bonus bonus Long-term Long-term Long-term incentive incentive incentive In addition, countries with a tradition of long-term incentives continue to pay higher rates than the overall market when it comes to total direct compensation. and, both countries with a propensity towards larger companies in their samples, top the league of highest-paying countries, whilst Nordic countries are the most restrained. Overall, the median total direct compensation of a CEO for a FT 5 company in was just above 3 million and that of other directors was just above 1.5 million. Figure 7: Median target total direct compensation as per cent of an median Hay Group. All rights reserved

8 17 Top executive compensation in 13 Sector trends National differences explain many of the variations in the sample, however sector movements play an equal role in driving our statistics. Figure 8: Median year-on-year per cent growth by sector (same job, same incumbent) Automotive Last year s high salary increases in the automotive sector did not continue. In early 1, lost ground on growth in the sector with falling sales and many an operations signalling restructuring activities. Having had the largest median fixed salary increase of all the industry sectors last year, this year was flat and the sector saw the largest drop in total cash as lower bonus levels brought a median decrease of 1.1 per cent Utilities and Energy A poor an summer in 1 followed by a cold winter allowed many utilities and energy companies to perform far better than in the previous year. Base salaries, which are typically strongly influenced by governments and regulators, only rose.6 per cent but the total cash increase was 1.6 per cent across the continent, reflecting increased bonus payouts. Banking Automotive Banking and finance Consumer goods Chemicals ICT Industrial Insurance Media.3 Mining.6 Oil and gas Pharmaceutical Retail Services Transport. Utilities and energy Other In spite of the industry having seen some positive developments in trading results during 1, public pressure, adjustments to accommodate the Capital Requirements Directive IV and the redistribution of income streams have so far kept remuneration increases low for the sector. Base salaries rose at the median by less than 1 per cent and total cash by 1. per cent. However, the sector is now facing a few difficult years as incentives are capped and there will be pressure to raise salaries while restructuring revenues and costs. The true consequences are yet to be understood, but are likely to begin with increasingly volatile pay. Growth in base salary Growth in total cash 13 Hay Group. All rights reserved

9 19 Top executive compensation in 13 Differences by role Insurance The insurance sector has not responded in the same way as the banking sector to regulatory and market pressures. Having learned to live with the low interest environment and helped by the improving performance of many stock markets and fewer catastrophes during 1, salaries increased by.1 per cent and total cash by a highly significant 13 per cent. Pharmaceuticals Pharmaceuticals remains true to its traditional positioning as the highest paying sector, despite recent rounds of strategic and structural change. The stock markets have been favourable to pharmaceutical companies and pay has followed with a median salary increase of nearly 8 per cent and total cash increasing by almost as much. This sector is the one to watch and we expect compensation to change as companies move from product centricity towards serving customer needs and better alignment with stakeholders; for example, responding to the changing attitudes and buying behaviours of governments. As we saw in 1, boards and their remuneration committees continue to hold back Chief executive officer pay increases. In 13, CEOs received a median salary increase of 1.1 per cent and a total cash increase of 1.5 per cent. However, with the added exception of Chief operating officers who have seen large increases over the past couple of years, other executive director positions grew pay significantly this year with total cash increases near or above 5 per cent. Figure 9: Year on year per cent growth in base salary by role (same job, same incumbent) Chief executive officer Human resources director Chief operating officer Chief financial officer Division head 1% % 3% % 5% Base Salary Total Cash Hay Group. All rights reserved

10 A final comment... Reward design is more vital than ever as companies confront pressure from various stakeholders to keep salary increases below that of other key talent groups and to maintain simple and uncontroversial incentives. As markets pick up, following the crowd is not an optimal starting point when re-engaging in the war for talent. In the first instance, there is a danger in becoming an also ran with no distinct proposition and no rationale linking behaviour, performance and reward. In the second instance, using the safety valve of easier performance targets for incentives will not only lose the proper pay-for-performance link, but also distort planning, budgeting and strategy implementation. For many years, investors have highlighted that one of the most significant weaknesses of corporate governance is how boards deal with remuneration. If poor management of executive reward through bad design or lacklustre decision making is not to spark the next round of governance and regulatory interventions, companies must differentiate themselves from the rest by being ready to reevaluate reward. For further information To purchase the full study, or for more information, please contact your local Hay Group executive reward expert: : Carl Sjostrom I Carl.Sjostrom@haygroup.com : Eric Engesaeth I Eric.Engesaeth@haygroup.com Austria,, : William Eggers I William.Eggers@haygroup.com : Caroline Robard I Caroline.Robard@haygroup.com United Kingdom: Simon Garrett I Simon.Garrett@haygroup.com : Sergio Perez I : Enor Signorotto I Enor.Signorotto@haygroup.com Belgium: Walter Janssens I Walter. Janssens@haygroup.com Nordics: Juhani Ruuskanen I Juhani.Ruuskanen@haygroup.com Turkey: Serkan Sener I Serkan.Sener@haygroup.com Alternatively, please execrewardeurope@haygroup.com

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