The Independent Fat Cat List 2003

Our business and city editor, Jeremy Warner, introduces a unique at-a-glance guide to the good, the bad and the outrageous in boardroom pay at Britain's 100 leading companies

Never has executive pay been more in the limelight than it is now. While share prices languish deep in the doldrums after one of the worst bear markets on record, executive pay, pensions and perks are still apparently continuing to soar.

Never has executive pay been more in the limelight than it is now. While share prices languish deep in the doldrums after one of the worst bear markets on record, executive pay, pensions and perks are still apparently continuing to soar.

It seems that barely a day passes without another company and another leading business figure featuring in newspaper headlines in a controversy over remuneration. Inevitably, the beneficiaries have been dubbed fat cats, and the real anger is over those with the most handsome remuneration packages who are presiding over companies which are hardly enjoying soaraway success.

The debate is made all the more highly charged by the closure of final-salary pension schemes, which many companies say they can no longer afford for all staff, and the repeated rounds of redundancies that large numbers of chief executives have pushed through.

At the same time, new rules which give shareholders a direct vote on the remuneration policies of their companies have heightened shareholder activism, forcing once supine institutional investors to voice the concerns of their clients.

So The Independent has decided to take stock: to investigate the links between benefits for leading executives and failure for the country's top companies. It is a difficult exercise, and an illuminating one.

Whatever methodology is used to compile a fat cat league table, there are bound to be caveats and anomalies. None the less, we believe the accompanying table as fair an analysis as can be achieved of the relative value for money that investors are getting from the chiefs of Britain's top 100 companies.

We have calculated the remuneration package as basic pay plus cash and shares benefits for the company's last reported financial year. We have also included the increase in the transfer value of the executive's pension pot, as this represents the extra cost to the company of funding his or her final salary pension entitlements. Where the executive is in a defined contribution scheme, we have included the company's contribution. We have not included the value of realised share options, which in some cases was considerable, because this information is not always included in the accounts.

In compiling the league table we have assigned marks out of 10 for the level of remuneration, with the top 10 earners receiving 10 points and the bottom 10 earners receiving one point. Those in between are divided into corresponding sub-groups of 10. Similarly, we have ranked companies according to total return to shareholders – that is share price performance with dividends added back. The 10 worst performers receive a 10, while the best performers receive a one. Total marks of 20 therefore represent worst value for money, and three, best value for money.

Shareholder return has been taken over three years so as to compensate for the possibility of big one-off negative or positive adjustments, such as the payment of a special dividend, in any single year.

This might be thought of as unfair, since three years largely coincides with the bear market, where the previous bubble sectors of technology, telecommunications and media have performed much worse than others. However, the underperformance of these sectors is largely because they have destroyed more shareholder value than others by over-investing in the boom. Even on a six-year rate of return analysis, which irons out the effect of the bubble, the results are not so dissimilar, with 14 of the companies in the top 20 showing poorest value for money on a three-year basis also showing it on a six-year analysis.

The notable exceptions are Sir Christopher Gent, chief executive of Vodafone, Sir Terry Leahy, chief executive of Tesco, and Tony Ball, chief executive of BSkyB. All three are top earners, but on a six-year basis, their relative rate of return to shareholders was much better than on a three-year analysis.

The table makes for some surprising as well as some unsurprising reading. It won't have surprised anyone, for instance, that Sir Peter Bonfield, former chief executive of BT, and Ian Harley, former chief executive of Abbey National, are two of the fattest cats of the lot, with a combination of very high pay and exceptionally poor performance. Both presided over a calamitous decline in the fortunes of their companies, mainly because of strategic mis-calculation and mis-management.

Likewise, that Sir Kenneth Morrison, chairman of the WM Morrison supermarkets group, and Christopher O'Donnell, chief executive of the surgical products company, Smith & Nephew, find themselves scoring particularly well on value-for-money criteria is not a huge surprise. Both lead highly successful companies but are paid relatively modestly.

More surprising is that some of Britain's most highly regarded chief executives also find themselves towards the top (that is, the "poor value" end) of the table – Lord Browne, chief executive of BP, Sir Terry Leahy and Tony Ball being the three most notable examples. All three are exceptionally well paid, but on a three-year view, returns to shareholders have been poor or pedestrian.

The table takes no account of the relative difficulty of running these companies, or their size. An argument can be made for higher rates of pay in larger companies, where the management challenge might be thought correspondingly bigger, or in those companies facing particularly difficult market circumstances.

Nor does the table take account of the fact that some chief executives, notably Michael Dobson at Schroders, haven't been in their jobs for very long, and therefore cannot be held accountable for the share price under performance. In his case, very high remuneration was thought a price worth paying if he succeeds in turning the company around.

Despite these caveats, the table reasonably demonstrates that in many cases, rates of pay have little to do with performance and results.

What a chief executive earns seems to be limited only by his powers of negotiation.

The main problem with boardroom pay in top companies is that it conforms to international standards, for which read American, rather than British. The debate over Jean-Pierre Garnier's pay at GlaxoSmithKline is instructive. By British standards, it looks huge, and the terms of his contract offer him a degree of protection which make it of little consequence to him financially whether he succeeds or fails. Either way he hits the jackpot.

Yet by American standards, JP (as he is known in the company), makes only a quarter of his nearest peers. GlaxoSmithKline is listed and domiciled in Britain, but these days it is as much an American company as a British one. JP runs the ship from America, which also accounts for half the company's profits.

In other cases of high pay for relatively poor performance no such argument can be made. For instance, Granada's overseas interests are very limited. So too are BSkyB's. Yet the chief executive's pay has begun to be set by "international" standards in these companies too, and in many cases is an exceptionally high multiple of average pay in the companies they lead. Here it is the headhunters and the remuneration consultants that have the most to answer for.

By making corporate promiscuity an acceptable form of behaviour for top executives, the headhunters have succeeded in creating an ever upwards spiral in executive pay. Similarly, remuneration consultants are used internally to help keep pay competitive with rivals, again leading to a constant ratcheting up of pay and perks.

The FATSE 100: how the list was calculated

1. The Independent's ranking has been calculated by comparing shareholder return in the FTSE 100 with total pay, including pension contributions from the company, using figures from the last available accounts. The 10 companies with the worst shareholder return have scored a 10, while the 10 best performers have been assigned a 1, with the rest divided into equal sub-groups of 10. The same approach has been applied to pay, with the top earners assigned a 10 and the lowest a 1. The two figures have been added together to give a total ranking. Total shareholder return has been calculated over a three-year period to compensate for one-off items, such as write-offs or special dividends.

2. Total pay includes pension contributions. This is the amount the company has had to commit in its last financial year in order to meet the pension entitlements of the director. Where the transfer value was unavailable, the company's contributions into the director's pension scheme have been used. For directors who are members of more than one pension scheme, the total amount contributed by the company into the various schemes have been used.

3. In cases where companies have not been listed for three years, their shareholder returns have been taken from the point they were listed. Shareholder returns include dividends as well as share price movement.

4. The executives chosen are the highest-paid of either the chief executive or the chairman, according to the most recent annual report. In some cases the individuals have since left the company.