Executive Share Options:
Linking Boardroom Pay To Company Performance

Much higher issues of executive share options, in return for a reduction in traditional ‘base-plus-bonus’, would produce boardroom pay packages that are far more closely linked to company performance. That is the conclusion of Brian Main, Trevor Buck and Alistair Bruce, writing in the latest issue of the Economic Journal. Analysing sixty FT-SE 100 companies over the course of the 1980s, they find that executive share options significantly increased the extent to which directors’ remuneration was sensitive to the creation of shareholder wealth. This result holds whether boardroom pay is measured by that of the highest paid director or by the pay of the entire board.

Main and his colleagues use a hitherto neglected data source for their study of the relationship between pay and performance: the ‘Register of Directors’ Interests’, which each company is required to keep, and which records the grant and exercise of share options for each director by name. Combining this with stock market and other company data, they find that:

Adding the share option component of remuneration to the more commonly discussed base-plus-bonus payment significantly raises the overall level of pay. In 1981, base-plus-bonus averaged £142,000 among the top paid executives in the sample; by 1989, this had increased to £357,000. By contrast, for the broader measure of pay, including executive share options, the average was £148,000 in 1981, rising to £566,000 in 1989.

In 1989, in terms of base-plus-bonus in the typical company, the relationship between pay and performance was modest: for every £1 million of shareholder wealth created, the average executive received £38 on a salary of £357,000.

But on the broader measure of pay, the link was markedly stronger: for every £1 million of shareholder wealth created, the average executive received an extra £239 on a typical option-inclusive package of £566,000.

Main et al note that a common complaint in the discussion of top executive pay is that it is only weakly linked to corporate success. But the recent Greenbury Report on directors’ remuneration strongly discouraged companies from using executive share options as incentive pay. Instead, following Greenbury’s recommendations, many companies have implemented long-term incentive plans (‘L-Tips’), the design and operation of which are often more obscure than the share option schemes they replace.

These researchers are in no doubt that executive share options are highly effective at rewarding executives for enriching their shareholders. They believe that there is scope for them to play a more important role:

The connection between pay and performance is automatic and unlike alternative arrangements, such as L-Tips, the link does not rely on the discretion of fellow directors acting through the remuneration committee.

At the same time, certain improvements in the use of executive share options as performance incentives are desirable. Their issue should be more clearly recognised in company accounts as a valuable component of pay; and directors should be encouraged to take more share options in return for a reduction in their base-plus-bonus pay.

Such improvements require changes in attitude by both the Accounting Standards Board, which governs the reporting of executive share option grants in company accounts, and investing institutions like the Association of British Insurers, which exercise regulatory influence over the issue of executive share options. Either way, the Greenbury report’s attitude to share option schemes remains difficult to understand.

ENDS

Note for Editors: ‘Total Board Remuneration and Company Performance’ by Brain Main, Alistair Bruce and Trevor Buck is published in the November 1996 issue of the Economic Journal. Main is Professor of Economics at the University of Edinburgh; Bruce and Buck are at the University of Nottingham.

For Further Information: contact Brian Main on 0131-313-8360 (email: Brian.Main@ed.ac.uk); or RES/ESRC Media Consultant for Economics Romesh Vaitilingam on 0171-878-2919 or mobile 0468-661095.