Easy option for bosses to inflate pay packet : YOUR MONEY

A leading accountant assails schemes for senior executives to buy shares at fixed prices in the future
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The Independent Online
FAT rewards for utility company bosses are an issue guaranteed to raise the hackles of any member of the public - especially when gas and electricity bills are thudding on to door mats.

Chief executives are now notoriously well paid. Cedric Brown, chief executive at British Gas, was awarded a 75 per cent pay rise last year, increasing his salary to £475,000 a year. Sir Desmond Pitcher, 59, became chairman of NorthWest Water in 1993; a role he combines with his chairmanship of Mersey Barrage Company and Mersey Development Corporation.

His £315,000 salary at the water company represents nearly a six-fold rise on that paid to his predecessor in 1989/90, shortly before privatisation.

But executives these days do not just get paid salaries They receive remuneration packages that include pay, performance bonuses, pension contributions, perks and share options. And these can prove to be the juiciest rewards of all.

James Smith has been chairman of Eastern Electricity since 1990. Last April, he made £466,287 on top of his £237,000 salary by cashing in his share options. His salary before privatisation was £68,000. If things go well at British Gas, Cedric Brown could get as much as £1m a year if his bonus shares and share options turn up trumps.

Singling out privatised company bosses for anger is, however, to miss the point. The scale of their remuneration and the way it is calculated are commonplace in British boardrooms. Remuneration packages are awarded by remuneration committees of outside directors, who are almost all members of the same charmed circle.

A recent study of 374 companies quoted on the Stock Exchange showed that their senior executives have between them received more than £10.5bn in share option schemes.

Share option schemes are a simple concept. They involve someone being given the right to buy a parcel of shares in the company they work for. The share price at which the option is set is higher than the current one, and a time limit - usually three years - is placed on the right to buy the shares. If the shares fall, or fail to meet the performance target, the options are worthless. If the company's shares go up by more than the target price, however, the person who has the right to buy them can exercise his option at that pre-set price. The shares can then be held or resold for an immediate profit.

Only rarely do shareholders revolt against such schemes. One recent example was that of Saatchi & Saatchi, where Maurice Saatchi was eventually ousted from the company he helped found. But Charles Scott, chief executive at Cordiant, as Saatchi is now called, could qualify for more than 2.5 million company shares in addition to his £320,000 salary, plus the options he already holds to buy 452,000 shares in the newly renamed firm.

Share option schemes are usually justified by the argument that they reflect improvements in company performance made by the senior executives. But if the targets are easy to reach, share options become little more than money for old rope.

A damning study by KPMG Peat Marwick, published last week, cast grave doubt on the whole incentive argument. It showed that two-thirds of share option schemes operate without performance targets for their senior executives.

David Tuch, a partner at KPMG's tax advisory service, said: "There are many schemes in existence where options are being granted without any type of performance condition." To make a profit, option holders in these schemes simply need the share price to have risen by the time they exercise their options.

"As share prices are remote from the activities of the average option holder, these options do not operate as effective incentives. If executive share options are to retain any credibility and shareholder support, companies must ensure they work in a credible way," Mr Tuch warned.

The KPMG survey did discover that companies that have introduced option schemes for their executives since 1988 are more likely to have set performance targets.

But even here, 47 per cent of schemes do not. This absence of performance targets is much more likely to apply to small companies worth less than £10m - more than 80 per cent of these have no targets, compared with 45 per cent of companies valued at more than £1bn.

There is, of course, nothing to stop option schemes being extended to employees at all levels, which would widen incentives and dull criticism. But KPMG's report found that option schemes are usually used exclusively for top management. "Just over half the companies granted options to their middle management, but the lower the grade of employees, the less likely they were to be granted options," it said.

Only 14 per cent of employers extended their schemes to non-management employees, although there was a significant difference between large and small companies.

Those valued at £10m or less had a non-management participation of 32 per cent. But, as with all these things, there was a snag even here. "Smaller companies may use share option schemes as a means of supplementing comparatively low salaries or a lack of other benefits," the report said.

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