Too Much of a Good Thing

(Bloomberg) -- If any company has enjoyed diplomatic immunity in the conflict over high pay, it's British turnaround specialist and star performer Melrose Industries Plc. Next week's annual shareholder meeting is a chance to send a message that what seemed acceptable in the past is no longer so.

Back in 2012, Melrose started a five-year bonus program tied solely to shareholder returns. The plan would pay executives 7.5 percent of the gain in Melrose's value over the period plus dividends, in excess of retail price inflation plus 2 percent. The uplift was to be adjusted for any fresh capital shareholders put in.

At the time, Melrose predicted the program would cost about 60 million pounds ($81 million). It paid out more than four times that amount when it matured last year. Four top executives received 42 million pounds each.

They did well because investors did well on the measure of total shareholder return over the designated timeframe. According to Melrose, the total value added by the end was about 3.6 billion pounds, for an annual return of 22 percent. That understates things: the company assumes investors didn't reinvest dividends. Those that did would have made twice the returns.

Yet shareholder advisory firm Glass Lewis is now recommending a vote against the pay and rations section of the annual report at next week's gathering. It argues that the payouts were just plain too big and the share-price formula is too crude.

It's hard to disagree. The inflation plus 2 percent hurdle is a low threshold. It meant generating an annual return of roughly 4.5 percent in the period. The vast majority of companies in the 636-member FTSE All Share Index managed that, according to Bloomberg data.

Then consider the impact of a rising market. Melrose says that for the purposes of the plan it was worth about 1.5 billion pounds in March 2012. Shareholders injected 1.2 billion pounds and 1.7 billion pounds in 2012 and in 2017 to help finance acquisitions. Had all these sums been invested in the FTSE All-Share instead, they would have generated a 2 billion-pound gain when the bonus plan matured (assuming the dividends were reinvested). That takes some of the shine off Melrose's value-added number.

Now apply common sense. Does 42 million pounds sound like the value of any employee's individual contribution to the business over five years? Does it sound like the minimum bonus you'd have to offer an equally skilled manager to be hired to do the same job? Not really. These are numbers more commonly associated with running a multinational with considerably more staff.

A pact between investors and managers to share the returns Melrose generates has worked for both sides so far, even if the rewards were asymmetric — the bosses wouldn't have suffered with shareholders on the downside.

Nevertheless, a plan that pays out quite so handsomely and on such narrow metrics sits ill with the requirement in U.K. company law that boards consider all stakeholders, as well as corporate reputation and the environment. That's a snag with long-term incentive plans in general, as they are typically tied to share-price performance.

The zeitgeist is changing — witness the recent revolts at Inmarsat Plc and Unilever. Investors are asking how much pay is too much pay. A vote against the remuneration report at the meeting wouldn't undo what's been doled out. But it would nudge the company to put a cap on the current bonus plan that runs to 2020. It might be inconsistent to protest something you had previously approved. But better to be inconsistently right than consistently wrong.

To contact the author of this story: Chris Hughes at chughes89@bloomberg.net.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net.

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