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Historic shift in executive remuneration worldwide

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Historic shift in executive remuneration worldwide


 



Article summary

 

Global growth, regional hotspots and executive talent shortages are leading to a dramatic change – by region – in pay for performance and executive remuneration program design and governance.

 

 

In this issue, answers to:

 

  • What are the current trends in executive remuneration in different parts of the world?

 

  • What are companies doing this year in light of these trends?

 

  • Which actions should organizations consider taking?

 


 

Today, substantial growth in emerging markets is altering the way business leaders view the world’s diverse markets. As economic hotspots arise in Asia, the Middle East and other emerging economies – and surpass entrenched leading economies – the long-held assumptions about growth, executive talent supply and executive remuneration have changed.

 

Rapid growth, leadership shortages and inflation in countries such as China and India have created record increases in executive pay. This is leading to a worldwide changing of the guard, from the West to the East/ Middle East. For some time, western-developed economies have posted the highest average compensation, but we’re seeing a dramatic shift as supply and demand factors wreak havoc on talent supply. Last year, average executive salaries in Asia surpassed those in Europe, and they are on track to surpass those in the US, perhaps in 2013. In the Middle East, executive salaries have already caught up with those in Europe.

 

In addition to pay, we’re seeing increased attention paid to performance, as slowing economies try to get the most out of their diminishing remuneration budgets and fast-growing markets try to hold on to their top talent. In some regions, the worldwide economic crisis has led to governmental action to establish new rules and regulations that promise to further transform the executive remuneration landscape. And finally, large organizations almost everywhere are showing heightened awareness of and placing emphasis on long-term incentives (LTIs) and leadership development.

 

Following is a regional snapshot of current trends in executive remuneration and future expectations by Mercer executive remuneration experts around the world. These thought leaders have closely studied the landscape and have spent countless hours with industry and company leaders discussing trends and charting paths to success.

 

 

Asia Pacific

 

Top trends for 2011

The first trend is the rapid increase in executive pay in the Asia Pacific region, especially in China, India, Indonesia, Vietnam, the Philippines and Malaysia. Contributing factors include continued strong growth in Asia’s industrial production and GDP, accelerating inflation across the region, a scarcity of executive talent and difficulty filling executive positions. While average executive salaries are increasing by 7% across the region, in Europe and North America the comparable rates are approximately 2.5% to 3.0%. Executive salaries in Asia are already higher than in Europe, and with an annual increase rate higher than in the US, we expect Asian executive salaries to surpass those in the US within the next two to three years.

 

A second, not unrelated, regional trend is a shortage of executive talent endowed with the ability to innovate, to think globally, to take risks and to move quickly. Such talent is mobile across Asia and, as a result, is driving up pay in some sectors to levels that may prove unsustainable.

 

Recommended actions

With high growth on the horizon for most companies in the region, clients should focus on attaining executive remuneration stability with the aim of long-term balance. Doing so requires innovative LTI plans that reward not just over three or four years, but perhaps over 10 years or 20 years, even up to retirement. Since the results of major executive decisions often do not become apparent until many years later, executive rewards should be tied to performance during the time when these results become real and apparent.

 

Companies should also ensure that they keep a sufficient component of pay as variable and flexible so that they only pay for measurable performance, and so that total remuneration levels are sustainable over time.

Australia

The most significant events of 2011 will be the proposed amendments to the Corporations Act as part of the government’s drive to curb executive pay. If implemented, the proposals will apply to all listed companies starting in July 2011. Three of the proposals most likely to affect clients include:

 

  • A “two strikes” rule that requires all board members to submit for re-election if the resolution to approve a company’s remuneration proposals is voted against by at least 25% of voters in two successive annual general meetings

 

  • A requirement that the board must approve the engagement of all remuneration consultants on remuneration issues related to the CEO and key management personnel

 

  • Obligatory comprehensive disclosure of consultants engaged to provide remuneration advice for the CEO and key management personnel

 

The second trend is a focus on key talent. The skills shortage in Australia is expected to increase as economic conditions continue to improve, the job market grows and labor demands increase.

 

Recommended actions

In 2011, the main area for client focus should be pay for performance. Many of the votes against remuneration reports last year were a result of shareholders not agreeing that company performance supported fixed and variable pay levels. As a result, and especially if the two-strikes rule comes into play, boards will want to ensure that they demonstrate a link between pay and performance, and are fully transparent by adequately describing the performance requirements in their annual disclosure reports.

 

Companies should also focus on retaining the right talent, investing in future leaders and planning a talent pipeline of future leaders. Leadership development and succession planning are increasingly becoming areas of focus for boards and remuneration committees.

China

The economy is back to double-digit growth, and more foreign investment is pouring into the country. Like the economy, executive cash compensation is on the rise, after a slowdown last year, and is expected to hit a double-digit percentage increase, varying substantially by industry.

 

To provide additional incentives and motivation to executives, LTIs have become more important and critical in the China market.

 

Experienced executive talent is in short supply. The competition for executive talent has become even more acute with the rise in movement of executives between local and multinational companies. As the pay gap between the two has narrowed, more Chinese companies have started to tap into executive talent from multinational companies and vice versa.

 

Recommended actions

Companies in China have come to realize that they should take a more holistic approach to their executive compensation, focusing on multiple incentive vehicles with multiple time horizons, pay for measurable performance and leadership development.

 

The majority of listed companies currently use a single LTI vehicle that, in times of economic turmoil, they tend to simply stop using because it is not sufficiently flexible to allow for adjustments. Companies should therefore explore alternatives beyond share option schemes and use multiple vehicles or the combination of different LTI schemes to help deal more effectively with negative market conditions.

 

Leadership development should also be considered among incentives to retain and motivate executives. And companies should re-examine the pay-for-performance linkage and ensure that the rewards are clearly aligned with business results.

India

The economy is back on track for strong growth (pegged at around 9% this year), and this is placing considerable pressure on talent retention due to heightened talent mobility. The top trend in 2011 is likely to be the resurgence of equity-based pay at mid-management levels among smaller organizations that have not yet run into dilution pressures. There will also be greater pay governance at senior levels due to rapid pay increases in prior years, and increasing instances of inadequate delivery by the senior team. This will mean greater scrutiny by boards and compensation committees on fair use of remuneration benchmarks, increased use of performance criteria and more clawback provisions.

 

At mid levels, equity pay had worked as a strong retention factor prior to 2008; it also helped manage fixed pay costs and involve middle management in the overall performance of the company. However, with growing International Financial Reporting Standards convergence, the increased accounting cost of equity pay will limit its use and force difficult decisions.

 

At senior levels, pay had risen at a rate that was disproportionate to performance delivered, given the talent market dynamics. This imbalance will see some reining in by building in greater governance on how pay is delivered and linking a greater proportion of pay to value delivered.

 

Recommended actions

In 2011, clients will examine dilution levels, identify key workforce segments critical to business performance and plan equity programs that include critical levels and talent. Clients will also need to create specific programs for senior levels, considering performance factors at an absolute as well as a relative level. In addition, we expect more investment in leadership development and assessment programs that will help identify a leadership pipeline and ensure that pay programs are aligned to retaining and growing potential talent.

Japan

Unlike with some other countries, executive compensation in Japan has remained stable and includes the following characteristics:

 

  • Compensation levels are typically lower than in the US and Western Europe.

 

  • There is a smaller proportion of variable compensation, typically 20%–30% of total compensation.

 

  • Only about 40% of listed companies provide LTIs, such as stock options.

 

  • About 60% of listed companies abolished their executive retirement plans.

 

  • There has been no significant reaction to the new disclosure rules implemented last year – which have far fewer requirements than in the US. For example, the individual compensation does not have to be dis closed unless the total remuneration of an individual is JPY 100 million (about US$1.23 million) or more, and the number of such executives is only about 300.

 

Due to a shrinking economy, Japanese companies are working to expand their business outside the country. As a result, when it comes to executive compensation trends, many Japanese multinationals are trying to establish a compensation governance scheme that addresses the needs of both Japanese executives as well as locally hired executives located outside Japan. On one hand, many companies face attraction and retention issues due to their reluctance to provide LTIs to executives in their overseas subsidiaries. On the other hand, they face internal equity issues, as executive compensation levels are lower in Japan than in the US or Europe, and not many Japanese companies provide LTIs to their local executives.

 

Recommended actions

Companies should establish a compensation policy and governance rules, develop a talent and leadership pipeline, and prepare the platform that enables and enhances employees’ global mobility. In most companies, not enough resources are allocated to deal with these issues. For example, almost all Japanese multinationals lack a compensation and benefits position in their organization, and some of them have insufficient budget to purchase market compensation data.

Southeast Asia

Most companies in Southeast Asia are currently facing fast growth and a shortage of executive talent. In Singapore, we expect companies to continue to focus on performance-based plans, which have almost become the norm in the country. In Malaysia, stock-option plans are also being replaced by performance-based plans and share-based plans to improve retention. In both these markets, government-linked companies’ take on performance-based plans is consistently influencing the markets.

 

In Thailand, there is a greater recognition of the need for long-term plans for executives to drive retention, team behavior and performance – the key emphasis being executive retention to fuel growth.

 

Recommended actions

Long-term plans are seen as the engine to help fuel growth and retain executives. Boards should look at implementing combination plans that can help companies achieve both. We have observed that stock options are losing ground in favor of performance-based share programs for motivation and restricted share programs for retention. Performance metrics are also shifting toward long-term and strategic rather than merely short- term financial measures.

 

Europe and the Middle East

 

Top trends for 2011

Rapid growth in the Middle East and steady, but slower, growth in Europe have brought these two regions to a position of leveling in terms of trends in executive remuneration. This includes bonus deferrals and the introduction of LTIs without increasing the incentive pool. Studies of the financial sector in both regions have shown that these regions are undergoing similar cutbacks in the use of short-term incentives (STI), offset by base pay increases and a much greater use of deferred compensation LTIs.

 

According to Mercer’s Pan-European Financial Services Remuneration Survey, more companies are deferring part of their variable compensation, thus more effectively aligning bonus payouts with the time horizon of risks – from 45% of companies in 2009 to 67% in 2010. The average period for a deferred bonus is three years, and the majority of companies have included a clawback feature, which allows an organization to take back previous performance-based payments on the basis of restated financials or a breached agreement.

 

In response to public concern, there have also been widespread reviews of, and reductions in, generous severance pay packages.

 

Recommended actions

Now is the time for organizations to ensure a better alignment between executive performance and stakeholders’ interests, finding a balance between risk and sustainability in their remuneration plans. They can start by examining the linkage between the performance management system and reward programs so there is a clear causational relationship between the decisions employees make, and the rewards that they receive.

 

In 2011, as part of their normal annual salary reviews, the vast majority of European organizations will increase executive salaries – with an average rise of 2.5%. Mercer forecasts that the base salary increase in GCC countries will be 6%–7.5%.

France

In terms of French executive remuneration trends, there is a new emphasis on defined benefit pension schemes as well as LTI policies.

 

Also, substantial changes have been made to regulations. There has been a significant increase in employee/employer social insurance contributions that has had a negative impact on the ratio and net/cost of these compensation schemes.

 

Recommended actions

Many companies in France are conducting a complete redesign of their existing defined benefit pension schemes and LTI programs or an analysis of possible alternatives in order to increase the global effectiveness of these schemes.

Germany

In Germany, changes to the Stock Corporation Act (Aktiengesetz) have led to more intensive scrutiny of management board compensation. In 2009, the act was amended in relation to a shareholders’ rights directive, executive remuneration appropriateness and other aspects, such as caps and vesting periods. Especially for listed companies, now the majority of the variable pay must be linked to a midterm incentive and/or LTI.

 

Germany is also seeing a review of incentive plans, with changes including a new focus on STI deferral plans (often used by the financial services industry), the introduction of new midterm incentives or the increase of existing LTIs. Performance-oriented LTI plans, such as performance share unit plans, are also coming into play more often as a way for companies to focus on both sustainable growth and share development.

 

Recommended actions

Clients should ensure appropriateness of management board compensation by reviewing the compensation package, including a comparison of the pension benefits against those of a market- and industry-specific peer group. In addition, in order to sustain growth, remain flexible and comply with the requirements for listed corporations, companies should review current incentive programs and align them to current business requirements. Overall, corporations have enlarged the supervisory board calendar to focus more on management board compensation and obtain a say-onpay vote in shareholder meetings.

Gulf Cooperation Council

Executive remuneration practices and standards across the Gulf are rapidly catching up with those in the rest of the world. Among the region’s trends for 2011 are the introduction of deferred bonus plans, assurance that annual incentive programs are linked more closely with specific corporate and division/business unit performance measures, and the introduction of LTI plans without increasing incentive pool costs overall.

 

Mercer survey results are forecasting base salary increases in 2011 ranging from 6% to 7.5%; for many companies, this will be the first pay increase in two years.

 

Recommended actions

Companies should review the performance measures in their STI plans to ensure that they align with new business priorities. If they have not done so already, to increase their motivational and retention value, companies should also examine the merits of deferred bonus plans; they should move away from an overly prescriptive approach to broader performance assessment in determining LTI plan payouts.

Italy

In Italy, trends continue to surround increased pay for performance. Another interesting trend is the “new era” of disclosure and transparency for all executive compensation elements – in particular, for the listed companies – due to the 2011 recommendations set forth by CONSOB (Italy’s stock exchange regulatory authority).  

 

Some additional notes on executive pay include:

 

  • Pure retention plans and “golden parachutes” for top executives are on the decline.

 

  • Peer-group comparison on executive remuneration and on Key Performance Indicators is growing.

 

  • There is a more balanced approach to the pay mix, with an increase in deferred compensation for variable pay for top and senior management.

 

  • There is a focus on introducing clawback provisions for STI payments.

 

  • Stock ownership guidelines are being introduced for LTI plans.

 

Recommended actions

Many companies are rethinking their executive compensation programs and must ensure a better alignment between executive performance and stakeholders’ interests, finding a balance between risk and sustainability in their remuneration plans.

 

On the other side, leadership development and succession planning are increasingly becoming areas of focus for boards and remuneration committees, and the HR function is working on these areas.

Netherlands

Mindful of the difficult economic situation of the past few years, many companies are cautiously moving forward and introducing incentives that can foster performance in the coming years.

 

Due to difficulty in setting targets in a volatile business environment, companies are experiencing flatter bonus payout curves and are introducing voluntary management bonus investment plans with matching shares subject to performance conditions, as well as sustainability-related measures such as employee engagement.

 

Recommended actions

Companies should consider replacing option plans with performance shares, moving away from total shareholder return (TSR) as a sole performance measure, introducing non-financial performance measures, adopting clawback provisions for payments made on materially misstated data and increasing management shareholding requirements.

Nordics

Two major executive remuneration trends are taking place in the Nordics. The first trend is increased recommendations that management hold a certain amount of shares in the company being managed, by amending either STI or LTI design features. To accomplish this, organizations often are adopting a vesting period, deferring annual bonuses or introducing a general shareholding requirement for senior management. This is due to increased pressure from different stakeholders – primarily investors and authorities – for senior executives to have exposure to the share price development over a longer period.

 

The second major trend is the increased use of manager discretion and individual differentiation by using a balanced scorecard approach that incorporates both financial and non-financial measures for performance evaluation. Companies are increasingly looking for ways to gain more return on their reward investments within a limited amount of time.

 

Recommended actions

First, companies need to review their LTI arrangements and evaluate how well they support and align with the long-term corporate and people strategies. Second, companies are increasingly realizing that they need good linkage between their performance management systems and their reward programs to provide a clear causational relationship between what they do and the decisions they make, and the rewards and opportunities that employees receive.

Spain/Iberia

More companies are linking rewards with strategy and risk. They see LTIs as an important element in executive remuneration packages, with an annual economic target of 40% of base salary. The most common packages are three- to five-year bonus schemes based on the strategic business plan or value of the company.

 

Many of these changes are due to the increased competition for talent, changes to tax rules, new emphasis on linking strategy with rewards and rewards with risk, virtually flat salary increases and no STI pay because of limited results.

 

Recommended actions

With recent changes and new pressures, companies should rethink executive compensation strategies, look for best practices and redesign short-term variable pay and LTIs.

United Kingdom

The UK executive compensation landscape in 2011 will be dominated by governmental pressure on financial services companies to demonstrate a stronger link between pay, performance and organizational risk – specifically, to strengthen corporate governance and address the use of STIs at the expense of long-term sustainability.

 

There is considerable frustration among companies outside the financial services sector that the banking crisis has had a spillover effect on them. Changes to the FSA Remuneration Code came into effect on 1 January 2011; the compliance date is 31 July 2011. The FSA directive originally applied to 29 organizations in the UK and now applies to 4,500 organizations.

 

Organizations are under pressure to review their executive remuneration strategies. There are some often-competing factors for organizations to address: the need for talent retention balanced with employee engagement and corporate reputation. In 2011, we will see upward pressure on executive base pay and bonuses, where justified by performance.

 

Recommended actions

As a result of the banking crisis and recession, organizations are under intense pressure from regulators, the media, the public and shareholders. Overall, companies must implement responsible executive plans that drive business performance and value creation, secure key talent and withstand external scrutiny.

 

North and South America

 

Regional top trends for 2011 (North America)

The unprecedented scrutiny of executive pay continues unabated and is only intensifying. Shareholders, corporate governance advocates, legislators and regulators are demanding increased transparency in executive compensation programs and stronger alignment of pay and performance. As a result, executive management and compensation committees are under increasing pressure to be responsive and accountable to stakeholders and to address their concerns.

 

Recommended actions

As the economy continues to improve in North America and companies gain greater insight into their short-term results, we expect to see a return to a more rigorous pay-for-performance orientation.

 

The coming years may bring a blurring of the traditional STIs and LTIs. Many companies are considering multiyear “annual incentive” plans, with holdbacks and future performance multipliers, and tinkering with the notion of shortening the LTI performance period. Companies may eventually blend the two distinct incentives into one award, thereby allowing the management teams to focus on one set of metrics and then divide the award payout into current payout and deferred payouts. These deferred payouts will ensure that executives maintain a long-term focus and allow for an easier clawback of awards if malfeasance is discovered at a later date.

Brazil

In Brazil, more than 100 companies have completed a public offering, creating an IPO boom in the region. During the process of moving from small, family owned businesses, run by their founders, to complex, large, international corporations, the skill set of their executive team has changed significantly. These firms have aggressively recruited talent from subsidiaries of US or Europeans multinationals, as well as from other Brazilian multinationals who have started their professionalization in the 20th century.

 

Another trend pertains to increased foreign direct investments. Brazil is the BRIC country that attracted the most international investments during 2010, in the form of mergers, acquisitions and direct investments: 196 deals involving US$61.1 billion (47% of BRIC’s activity).

 

Recommended actions

Most companies that have completed an IPO have implemented a stock option plan. Since those companies did not offer long-term compensation prior to the IPO, these trends have increased the level of compensation in the Brazilian market, as well as the typical pay mix.

 

In spite of increasing levels of compensation, competition for talent is very tough due to the limited pool of candidates, and as a result, more companies are offering retention plans for key employees during mergers and acquisitions. In the war for talent, many subsidiaries from US and Europeans multinationals have also been increasing bonuses and equity grants.

Canada

In Canada, pay for performance has become the top issue in executive remuneration, particularly with respect to LTIs. While meeting shareholder expectations is clearly a driver, most companies simply see offering performance linked pay as the right thing to do. There is also an increase in the quantity and quality of information available through proxy disclosure and continued scrutiny of executive pay.

 

Recommended actions

Companies must consider what pay for performance means for them. For example, should “pay” be defined as the pay opportunity (similar to how equity-based LTIs are disclosed in the proxy) or realized pay, or both? Also, to what measure or measures of performance should pay be linked? Companies must test their historical pay and performance alignment and ensure that programs are designed to reflect their linkage in the future. They should clearly explain the business rationale for compensation decisions in their Compensation Discussion and Analysis (CD&A) and proactively engage with shareholders to understand their compensation- related concerns.

 

Other significant trends and concerns from Canadian organizations include:

 

  • Adopting say on pay

 

  • Implementing effective clawback policies

 

  • Assessing risk – conducting risk assessments and disclosing company’s risk management of its compensation policies and practices

 

  • Evaluating the level of executive pension benefits and the security of those obligations

 

United States

In the US, trends continue to surround increased pay for performance, particularly around LTIs and a diminishing reliance on stock options. In addition, the legislative and regulatory environment, specifically say on pay, coupled with increased scrutiny from shareholder activists, has caused many companies to rethink their executive compensation programs.

 

Recommended actions

Companies are trying to balance multiple priorities: aligning programs with revised business strategies, ensuring that payouts are commensurate with performance, setting realistic goals in a world where forecasting remains challenging and being responsive to shareholders. Meanwhile, companies are becoming increasingly concerned about their ability to retain their management teams and other critical talent. As companies begin to see improvement, they are luring seasoned talent away from competitors or even from companies in other sectors.

 

As a result, companies should ponder the following issues and related questions:

 

  • Performance goals – What are appropriate performance goal levels?

 

  • Pay for performance – What does it mean? How is it calculated? What must be disclosed?

 

  • Stock ownership requirements – What is the impact of not meeting guidelines?

 

  • ISS influence – What are the effects of increased focus on ISS policies and practices?

 

  • Clawbacks – How should they be structured and enforced?

 

  • Retention – What is needed to retain key talent as the economy improves and more job opportunities arise?

 

  • Risk and rewards – What can be done to ensure appropriate risk/ reward relationships?

 

  • M&A and severance – What are the appropriate severance levels and excise tax gross-ups upon change in control?

 

  • Say-on-pay results – How can companies best proceed in light of uncertainty regarding shareholders’ viewpoints on pay programs?

 

  • Executive retirement benefits – How will supplemental executive retirement programs and deferred compensation be viewed by various stakeholders going forward?

 

 

 

 


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Historic shift in executive remuneration worldwide

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This article is for information only and does not constitute legal advice; consult with legal and tax advisers before applying to your situation.

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Contributing authors


Asia Pacific


Regional & Hong Kong

E-mail Dr. Hans Kothuis

Australia

E-mail Christine Deveney

China

E-mail Wei Zheng

India

E-mail Shanthi Naresh

Japan

E-mail Koji Kimura

South Korea

E-mail Hoonsang Yoon

South East Asia

E-mail Fermin Diez


Europe and Middle East


France

E-mail Bruno Fourage

Germany

E-mail Bernd Thomaszik

Gulf Cooperation Council

E-mail Larisa Muravska

Italy

E-mail Marco Morelli

Netherlands

E-mail Piia Pilv

Nordics

E-mail Kristinn Haraldsson

Spain/Iberia

E-mail Yolanda Gutierrez

United Kingdom

E-mail Mark Hoble


North and South America


Brazil

E-mail Martin Ibanez-Frocham

Canada

E-mail Lisa Slipp

United States

E-mail Gregg Passin

United States

E-mail Seth Rosen