How boardrooms balance their executive pay over the coming year could be the difference between surviving or succumbing to the economic storm, according to new UK research.
An analysis of directors' remuneration at FTSE-250 by consultancy Hewitt New Bridge Street, part of Hewitt Associates, has suggested that remuneration committees will face a tough balancing act in the coming year.
On the one hand they'll need to be seen to be protecting shareholders' interests by keeping a lid on executive remuneration.
But, on the other, they will not want to screw things down too tightly and risk losing the vital executive talent they need to navigate their way through the stormy economic waters.
Remuneration issues, and in particular the way in which key executives are kept happy, challenged and motivated, will be a critical factor influencing how, or even if, British companies manage to deal with the economic downturn, it argued.
Rob Burdett, principal at Hewitt New Bridge Street, said: "We are now in uncharted territory. As the economy enters recession, remuneration packages are in the spotlight – directors need to be set achievable targets, while investors must be assured that reward levels are not excessive.
"One of the keys to business success in the current environment will be whether companies can successfully agree a reward structure that motivates, incentivises and retains executives in line with overall company objectives. However, this is easier said than done as the breadth and depth of the economic downturn remains unknown," he added.
The report found the average total target remuneration package of the highest paid directors was £1.3m last year, a lower increase than in previous years but still up between seven per cent and 10 per cent year-on-year.
The total packages of U.S chief executives continued significantly to outstrip their counterparts in the UK, the Hewitt poll also found.
U.S total packages were worth about 60 per cent more than their UK counterparts, mainly because of the higher levels of variable pay. By contrast, British finance directors generally received higher packages than their U.S peers, it argued.
While for executive directors most packages now typically consisted of two elements, fixed and variable pay, the past five years had seen a significant shift towards packages becoming performance-linked.
Performance-related pay now comprised around half of an executive's variable pay (for example their annual bonus and long-term incentive plans), as against 40 per cent in 2003.
Of the variable elements, there was most commonly a 44/55 per cent split between the annual bonus and long-term incentives, it added.
"Other than in some high profile instances, remuneration hasn't been such a contentious issue for the last couple of years," said Burdett.
"This is because a degree of consensus emerged on how executive pay packages should be structured, with the largely benign economic environment also helping. However, times have changed, with nearly all our clients now reviewing their remuneration packages, with a few considering making significant changes to reward structures," he added.
For some companies, long-term target setting could be very hard in the current climate, meaning they might be more inclined to increase bonus potential, albeit with more deferral of bonus into shares, argued Hewitt. This would also provide investors with the comfort that long-term performance is being factored in.
But, while most shareholders will be aware of the need for companies to retain and motivate crucial executives, some investors may need to be persuaded that now is the right time to make major structural changes to the remuneration framework, it added.
"Companies must review their reward structures to ensure the package is both appropriate and effective," argued Burdett.
"However, a knee-jerk reaction is not the solution. For some, amending packages within the current framework rather than implementing wholesale structural changes may be the best approach. For example, this might be achieved by setting new targets for future bonus and long-term incentive awards," he added.
If this year's bonus targets showed low or even negative growth compared with last year, executives might be happy to accept lower payouts than before for hitting their targets, he suggested.
Equally, firms that used relative total shareholder return as a basis for performance measurement would probably still be able to use the same target as in previous years.
But firms that used long-term financial targets such as these needed to ensure they were taking due account of the likely very difficult trading conditions over the next three years.
Now was also probably not the time to be setting over-optimistic targets that could encourage undue risk-taking, argued Burdett.
For directors, the average base salary was £485,000, while for finance directors the average overall package was around £800,000, up from £710,000 in 2007, on a base salary of around £325,000, the survey argued.
For the first time in recent years, the rate of increase in total remuneration for executive directors had fallen to 10 per cent per annum or less, Hewitt also found.
The average annual bonus was largely unchanged, at 100 per cent of salary, though in 2007/2008 the typical bonus paid was around 80 per cent of the maximum potential.
Given current economic conditions, bonus levels for 2008 were however likely to be lower, Hewitt warned.
Bonus share deferral was also now common, with more than a third of companies requiring part of the bonus to be deferred in shares for a period of time.
The average non-executive chairman's fee was £158,000, the survey also found, with senior independent directors receiving fees of around £53,000, non-executives chairing at least one committee £49,000 and non-executives with no chairmanships, £46,000.
Last month two surveys by consultancy Watson Wyatt also highlighted the central role executive pay was likely to play in the coming months.
In its first survey, of 50 financial services firms, it found just one was planning to introduce a pay freeze this year, despite deep public anger over banking bonuses.
And in the second, a U.S poll, it found almost half of firms polled said they were planning to reduce the size of their bonus pool this year.
Nearly a quarter said they were expecting to reduce bonuses and long-term incentives by at least half, with 11 per cent not paying any annual bonus at all.
And research by consultancy Deloitte in September suggested that, even in the downturn, high flyers will still be able to command top-dollar salaries.
While salary increases for British FTSE-350 executive directors had slowed as a whole compared with 2007, "business superstars" could still command a premium, it argued, with the average increase for executive directors as a whole now around 6.2 per cent, against seven per cent 12 months before.