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Part
6
Performance and Reward
394
are ostensibly intended to motivate directors to
achieve performance improvements for the business.
A more common although not always disclosed rea-
son for bonuses is to ensure that what is believed to
be a competitive remuneration package is available:
‘Everyone else is doing it so we must too.’
One of the problems with high bonus expectations
is that of the ‘moral hazard’ involved. For example,
directors might be tempted to manipulate reported
profits in order to drive up the share price, fre-
quently an important determinant of bonuses. Or
they may go for high returns in risky short-term
projects, ignoring the possible downside of longer-
term losses.
Executives may benefit by receiving bonuses for
performance that meets objectives but they do not
usually lose pay when their objectives are not achieved.
They only gain, they never lose. It can be argued
that they should get their base salary for doing their
jobs, ie achieving their objectives, and only receive
more in the shape of a bonus if they exceed expecta-
tions. It could also be argued that if that they fail to
meet their objectives they should be penalized by
not receiving a portion of their base salary, which
would then truly be pay-at-risk. Earn-back pay
schemes try to remedy this situation. Such schemes
require executives to meet agreed objectives in order
to earn back an element of base pay placed at risk.
If they do not succeed against the objectives, some
or all of the earn-back pay will be lost.
Long-term bonuses
Cash bonus schemes can be extended over periods
of more than one year on the grounds that annual
bonuses focus too much on short-term results. The
most common approach to providing longer-term
rewards is through share ownership schemes, as
described later.
Deferred bonus schemes
Some companies have adopted deferred bonus
schemes under which part of the executive’s annual
bonus is deferred for, say, two years. The deferred
element is converted into shares, each of which is
matched with an extra, free share on condition that
the executive remains employed by the company
at the end of the deferral period. Such a scheme is
designed to reward performance and loyalty to the
company.
Share option schemes
Many companies have share option schemes that
give directors and executives the right to buy a block
of shares on some future date at the share price
ruling when the option was granted. They are a
form of long-term incentive on the assumption that
executives will be motivated to perform more ef-
fectively if they can anticipate a substantial capital
gain when they sell their shares at a price above that
prevailing when they took up the option.
Performance share schemes
Some companies have performance share schemes
under which executives are provisionally awarded
shares. The release of the shares is subject to the
company’s performance, typically determined on a
sliding scale by reference to the company’s total
shareholder return (a combination of share price
growth and dividend yield) ranking against its
chosen peer companies over a three-year period.
Release is also conditional on the executive remain-
ing employed by the company at the vesting date.
Such a scheme rewards loyalty to the company and
the value delivered to shareholders in the form of
share price performance and dividends but does not
link directly to business performance.
Executive restricted share schemes
Under such schemes free shares are provisionally
awarded to participants. These shares do not belong
to the executive until they are released or vested;
hence they are ‘restricted’. The number of shares
actually released to the executive at the end of a
defined period (usually three or, less commonly, five
years) will depend on performance over that period
against specific targets. Thereafter there may be a
further retention period when the shares must be
held, although no further performance conditions
apply.
Benefits
Employee benefits for executives may amount to
over 20 per cent of the total reward package. The
most important element is the pension scheme,
and directors may be provided with a much higher
accrual rate than in a typical final salary scheme.
This means that, typically, the maximum two-thirds
pension can be achieved after 20 years’ service or
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