Our analysis of annual bonus payments and long-term incentive plans (LTIPs) calls into question their value, when they almost always pay out, and typically pay out at a very high amount indeed.
This reveals a fundamental problem with how executive pay is determined, since LTIPs and bonuses form the largest component of listed companies’ executive pay packages in the UK.
Our analysis of bonuses and LTIPs examines payments at FTSE 100 companies as a proportion of the maximum available under the terms of their pay policy, as documented in their annual report. This is for each year from 2009-2019, excluding 2020 because of the effect of the Covid-19 pandemic, and excluding years in which there was a change of CEO or in which there was no LTIP or bonus plan in place.
In the case of LTIPs, the analysis found that:
- LTIPs almost always pay out – a payment was made in 85% of cases.
- Generally, they pay out a significant proportion of their potential value – half of LTIPs paid out at least two thirds of the potential maximum.
- Very high pay-outs are common. More than one in five LTIPs (21%) paid out their maximum potential value. Including those that paid out at least 90 per cent, this figure rises to roughly one in three (32%).
- 36% of pay-outs are either at 0% or 100%, suggesting that in more than a third of cases performance was outside the range set, and presumably seen as realistic, by the remuneration committee – either below their minimum target or in excess of the maximum.
For annual bonuses, the analysis found that:
- Bonuses are even more likely to pay out than LTIPs, with 94% of bonus plans paying out at least some proportion of the potential maximum over the period.
- They generally pay out a significant proportion of their value – half of bonus plans paid out at least three quarters of the potential maximum.
- Though the median bonus payment was higher, as a proportion of the potential maximum value, than the median LTIP payment (75% versus 66%), fewer bonuses paid out at 100% of their value (12% as opposed to 21%).
- Similarly, the number of bonus plans not paying out at all was lower at 6%, meaning that a smaller proportion fell outside the performance range set in the pay policy – i.e. 18% of bonus plans paid either 0 or 100% of their maximum value, compared to 36% of LTIPs.
The susceptibility of LTIP targets to being overtaken by events has implications for the structure of executive pay awards. It raises the question of whether LTIPs are a robust mechanism for incentivising and rewarding good leadership, or something of a lottery, hugely dependent on the external context in which the company operates.
Our findings also have potential ramifications for the value of pay awards. Firstly, the very high proportion of bonuses and LTIPs paying out suggests that if these mechanisms are maintained, targets should be more demanding, with fewer and lower pay-outs, resulting in lower average pay.
Secondly, the frequency with which performance outcomes deviate from the range of possibilities set out in LTIPs highlights the limitations of boards’ and CEOs’ abilities to forecast and determine business performance. This challenges the notion of the superstar CEO and the imperative to pay vast sums of money to attract or retain executives, creating huge divides within the workforce.
This is something that remuneration committees should consider when contemplating the pay demands of their executives, and the pay gaps between high, middle and low earners throughout their organisation.