VideoLast month, Jan Hommen made a "moral appeal" to senior staff at his firm to pay back the bonuses they received a few weeks earlier, such was the public anger about payouts at ING, the Dutch bank that's been propped up by a government bailout. The tipping point, it turns out, was a 100,000-share award—worth up to €1.3m—to incoming CFO, Patrick Flynn. It was difficult for Hommen, ING's supervisory board chairman, to justify this and previous payouts amid widespread scorn.
There is no doubt that executive pay at banks will change dramatically, given the state aid they have received and the blame for the financial crisis heaped upon them. That said, "there is bound to be a certain amount of seepage into the broader executive scene," says Calvin Jackson, a senior consultant at Watson Wyatt. Though the changes may not be as radical, non-financial companies will still find it difficult to justify previous pay practices.
Take Volvo. In February, the Swedish truckmaker said that according to recent benchmarks, its executives were underpaid in relation to competitors. In response, the company wanted to raise the ceiling for performance-based pay as a share of salary and boost the amount of shares in its long-term incentive plan. In the wake of a large fourth-quarter loss and more than 16,000 layoffs, the backlash was swift, with Sweden's prime minister, Fredrik Reinfeldt, calling the actions "offensive." Within a week, the company was forced to rescind the proposal.
Not the only company experiencing losses and layoffs, Volvo serves as a useful example for firms struggling to retain, motivate and reward executives in a hostile environment. "When I read the newspapers, it seems that executive pay is responsible for the entire financial crisis," says Xavier Baeten, manager of the Executive Remuneration Research Centre at the Vlerick Leuven Gent Management School in Belgium. Opinions vary widely on what the ideal executive pay package should include, with greater consensus about what should not be allowed. (See "Seven deadly sins" at the end of this article.)
Just rewards
For its part, the European Commission urged member states in late March to address "excessive" executive remuneration. All members should mandate disclosure of pay policies and individual directors' pay, the commission asserted, adding that only two-thirds do today. Executives should have "no involvement whatsoever" in setting pay, severance should be restricted to two years' worth of salary and benchmarks should take account of pay variations both inside and outside a company. As always, however, the follow-through on these proposals will lie with each member state.
To date, Germany has gone further than most. A draft bill expected to be passed by this summer requires listed companies to have, among other things, executive packages with long-term incentives of at least four years and charges the entire supervisory board—not just a sub-committee—with responsibility for setting pay policies. Executive compensation must also be "adequate" and "customary" in relation to individual, corporate and industry performance. Given the bill's vague language and uncertain enforceability, it is "more or less a threat," notes Kerstin Schmidt, a partner at Lovells in Dusseldorf. The "vivid" expression of anger by the general public is more likely to drive change to pay policies, she adds.
Whatever the starting point, experts predict a range of reactions as companies rewrite the traditional rules. "We are in completely uncharted territory," says Mary Robertson, an interim HR executive and director of Reward Matters, a consultancy. "A year ago, I was doing a lot of work on flexible benefits and elaborate incentive schemes," she says. Today, with cash scarce and bonuses taboo, she is "helping companies spend the money they have better." This often includes making incentive plans simpler.
For most firms, the simplest form of pay—base salary—is likely to be frozen for at least this year. However, the share of fixed pay in remuneration packages—around 30% at most large European firms—is likely to grow as variable pay shrinks. (See chart at the end of this article.) With previous performance targets now almost impossible to achieve, lower hurdles will be needed to ensure executives are realistically motivated. "Shareholders will be willing to accept lower targets for future rewards but the quid pro quo might be a smaller reward," says Rob Burdett, a principal at Hewitt New Bridge Street. Of course, in the current job market, many executives may be happy simply to remain employed. "A lot of executives would do their same jobs for 30% less," reckons Baeten of Vlerick.
The metrics for measuring performance-based pay are also likely to change, says Baeten. "You need, at maximum, five performance measures," he says, asserting that this won't affect the effectiveness of previous plans. "Going for simplicity can, in a way, make decisions more complex because CFOs will need to decide what performance measures really count for their companies," he adds.
What might these metrics include? Governance and compliance measures may find their way into incentives as companies aim to bolster risk management processes. And rather than ubiquitous EPS and TSR-based metrics, Peter Boreham, a director at Hay Group, expects "cash, cost control and customer" measures to rise in importance. This means that the trend towards uniformity in pay packages could reverse as company-specific measures gain prominence. "This is a time when the market has never been less relevant to remuneration committee decisions," adds Eric Duffelen, a principal at Towers Perrin.
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