The Remuneration Committee has an established peer group for benchmarking purposes, made up of FTSE 100 companies with a consumer goods focus, an international spread of operations and competitors for top management talent. This group of UK listed companies (the Salary Comparator Group) has been used for a number of years to ensure that base salaries and total compensation continue to be market competitive and is subject to annual review. The companies in the Salary Comparator Group as at 31 December 2006 are set out in Table 6.
The opportunity provided by the total package was compared against the Salary Comparator Group on both an expected and projected value basis, taking into account the value of the LTIP Dividend Equivalent. Under both these approaches, the total compensation opportunity for the Executive Directors, and in particular the Chief Executive, was positioned appreciably below the mid-market.
To ensure that remuneration levels remain competitive (subject to the approval of shareholders), awards under the New LTIP will therefore be increased from 175 per cent to 250 per cent of base salary for the Chief Executive, and from 125 per cent to 200 per cent of base salary for the Finance Director and the Chief Operating Officer. In this way, the total package continues to be positioned appropriately against the market.
The level of award for members of the Management Board will also be increased from 125 per cent of salary to 150 per cent of salary.
In order to provide flexibility and sufficient capacity for future awards over the life of the Plan, the individual limit will be increased to 300 per cent of salary. The Remuneration Committee does not anticipate that awards will be made up to this limit in normal circumstances, and there is no current intention to utilise this limit by making awards in excess of the proposed levels. The Remuneration Committee will advise shareholders in advance of any change in the current proposed award levels, and any such change will be disclosed in the Remuneration Report.
Salaries for the Executive Directors and members of the Management Board are reviewed annually or on a significant change of responsibilities. In deciding appropriate salary levels, and to ensure competitive positioning, Executive Directors’ salaries are benchmarked against a mid-market level of main board directors from the Salary Comparator Group described above. Where necessary, additional reference is also made to published salary data, including that for positions for companies in the Salary Comparator Group.
Matched salary positions are identified and compared using factors chosen to cover comparative reporting levels, revenue, international responsibilities and main board membership. This enables a mid-market assessment and a ‘competitive range’ (typically 15 to 20 per cent either side of the assessment) to be reported to the Committee, which will then make judgements within this range depending on individual performance and experience.
Salaries of members of the Management Board are reviewed on the basis of a mid-market comparison for equivalent management board roles. Similar principles are applied to the salaries of senior managers and, below this level in the organisation, salary scales are graded with reference to market conditions whilst individual salary increases are linked to performance.
During 2006, the Committee continued to recognise that the requirements of recruitment or retention may on occasion justify the payment of a salary outside the range regarded as appropriate for a particular position.
In addition to basic salary, the Executive Directors and members of the Management Board receive certain benefits in kind, principally a car or car allowance and private medical and personal accident insurance. The Executive Directors also receive the benefit of the use of a driver.
Executive Directors’ performance-related bonus plans
With effect from 1 January 2006, the Executive Incentive Scheme (annual cash bonus) and the Deferred Share Bonus Scheme were combined under one vehicle to create a higher impact, more focused and simpler annual incentive arrangement called the International Executive Incentive Scheme (IEIS). The Executive Directors participate in the IEIS, which is an annual bonus scheme for senior managers, comprising both a cash and deferred shares element. The deferred shares element is delivered through the Deferred Share Bonus Scheme (the Deferred Scheme). The IEIS aims to reward short term performance within the context of longer term sustainability.
The role of the IEIS was also considered during the long term incentive review referred to above; there are no changes currently planned or proposed to the annual bonus arrangements.
Bonus entitlements and awards to the Executive Directors and members of the Management Board under the IEIS depend upon the performance of the business. Demanding targets are set by the Remuneration Committee at the beginning of each year, and are measured in terms of both financial and business performance. Since the beginning of 2006, the targets for the IEIS reflect five common measures: underlying operating profit, market share of key player volume, Global Drive Brand volume, net revenue and cash flow. These measures, identified as being key to sustained performance, have an equal weighting of 20 per cent each. Payouts for each target are determined on a sliding scale with three performance points: threshold (which must be exceeded to attract a bonus); target; and maximum amount (the level at which the bonus is capped). The specific targets are not disclosed as they are considered to be commercially sensitive.
The performance points are calculated at the start of the year by reference to the type of target and projected performance in the context of the Group’s annual budget. The Committee receives reports from internal functions to allow it to determine the extent to which performance measures have been achieved. No elements of the bonuses are guaranteed. Bonuses will be equally delivered in cash and shares.
Awards made under the Deferred Scheme are in the form of free ordinary shares in the Company which are normally held in trust for three years and no further performance conditions apply in that period. In certain circumstances, participants may forfeit the shares if they resign before the end of the three year period. The Remuneration Committee is keen to encourage a culture of ‘ownership’ of these awarded shares and, since April 2004, participants have received a cash sum equivalent to the dividend on the after tax position of all unvested ordinary shares held in the Deferred Scheme at the dividend record date.
For the Executive Directors, the cash and shares elements of the IEIS taken together carry a value of 100 per cent of base salary for ‘on target’ performance, with an overall maximum of 150 per cent. For the members of the Management Board, both elements taken together carry a value of 67 per cent of base salary for ‘on target’ performance, with an overall maximum of 100 per cent. The Committee, following its usual procedures, agreed that the performance targets for the year ended 31 December 2006 have been met (subject to confirmation of a figure yet to be published). These performance-related bonus payments are included in Table 1, in the year to which they relate.
Directors’ interests in shares
The interests of the Directors of the Company in the issued share capital of the Company, according to the register maintained under Section 325 of the Companies Act 1985 (which is open to inspection at the registered office), together with their interests in share options, are shown in Table 2
The Remuneration Committee continues to promote its shareholding guidelines under which Executive Directors and members of the Management Board are encouraged to work towards holding ordinary shares in the Company to the values of one times and 0.75 times base salary respectively.
Share options and share incentive schemes
The Executive Directors are eligible to participate in the following employee share schemes which are designed to incentivise employees of the Group by giving them opportunities to build a shareholding in the Company: the British American Tobacco Sharesave Scheme (Sharesave Scheme), the Employee Share Ownership Plan and the Current LTIP. Executive Directors have also participated in the British American Tobacco Share Option Scheme (Share Option Scheme) and in line with current policy, no options have been granted to Executive Directors or other participants under the Share Option Scheme since March 2004. The Share Option Scheme will expire in April 2008 and there is no intention to renew it.
All benefits under the employee share schemes are non-transferable and non-pensionable.
Eligible employees, including the Executive Directors, have been granted employee savings-related share options to subscribe for ordinary shares in the Company. In November 2006, the Company made a further grant of options under the Sharesave Scheme which allows for options granted to be exercisable in conjunction with either a three year or five year savings contract up to a monthly limit of £250. Options are normally granted at a discount of 20 per cent to the market price at the time of the invitation, as permitted under the rules of the Sharesave Scheme. At 31 December 2006, all the Executive Directors participated in the Sharesave Scheme, each saving the maximum monthly amount.
The Sharesave Scheme in its current form, which was initially approved by shareholders in 1998, will expire in April 2008. The Remuneration Committee has recommended that the Company continue to operate a Sharesave Scheme and that shareholders’ approval to renew the Sharesave Scheme for a further 10 years will be sought at the 2007 Annual General Meeting.
The rules of the renewed Sharesave Scheme will be substantially unchanged, although there is some updating of statutory references and the inclusion of provisions allowing for electronic communications. In order to bring the limits on the number of new shares which may be issued pursuant to the exercise of options granted under the Sharesave Scheme in line with current ABI guidelines and market practice, the Sharesave Scheme will be amended to provide for a single limit on the number of shares which may be issued under the scheme in any 10-year period of 10 per cent of the Company’s issued share capital. The Sharesave Scheme will continue to be approved by HM Revenue & Customs (HMRC), who have given their preliminary approval to the extension of the scheme in its amended form.
Employee Share Ownership Plan
The Employee Share Ownership Plan is an HMRC approved share incentive plan. The Company continues to operate its Partnership Share Scheme as a key constituent part of this Plan. The Partnership Share Scheme is open to all eligible employees, including Executive Directors. Employees can allocate part of their pre-tax salary to purchase shares in British American Tobacco. The maximum amount that can be allocated in this way is £1,500 in any year. Shares purchased are held in a UK-based trust, normally capable of transfer to participants tax free after a five year holding period. At 31 December 2006, all the Executive Directors participated in the Partnership Share Scheme, each investing the maximum monthly contribution.
The Company also operates the Free Shares element of the Plan, known as the Share Reward Scheme. Under this Scheme, eligible employees (including Executive Directors) receive an appropriation of shares in April of each year in which the Scheme operates in respect of performance in the previous financial year. In this way, an award will be made on 2 April 2007 in respect of the year ended 31 December 2006, subject to the performance conditions being met. For the Executive Directors, the performance conditions were aligned to those set for the IEIS in respect of the same performance period. The shares are held in a UK-based trust for a minimum period of three years. The maximum individual award under the Share Reward Scheme is £3,000.
Share Option Scheme
It is the policy of the Remuneration Committee not normally to grant options in any year to individuals who receive an award under the LTIP. No options have been granted under the Share Option Scheme since March 2004, with no options having been granted to the current Executive Directors since September 1999. As mentioned above, the Share Option Scheme expires in April 2008 and there is no intention to renew it. One Executive Director, Paul Rayner, holds outstanding options under the Share Option Scheme; these options were granted to Mr Rayner prior to his appointment as a Director in 2002.
Options already granted under the Share Option Scheme were not issued at a discount to the market price at the time of grant, with the value of options for that grant being limited to 50 per cent of a participant’s base salary. Options are normally exercisable after the third anniversary of the date of the grant and lapse 10 years after the date of their original grant, subject to a performance condition based on EPS growth. For options to be exercisable, the Company’s published adjusted diluted EPS growth has to exceed inflation by an average of 3 per cent per annum over any consecutive three year period during the 10 year life of the options. Current LTIP
Details of the framework and general operating parameters of the Current LTIP have been included as part of the summary of the Review and the proposed New LTIP referred to above, in which it is noted that the Current LTIP will expire in April 2008 and, subject to the required shareholders’ approval, the first awards under the New LTIP will be made in May 2007. Therefore, no further awards will be made to the Executive Directors and the members of the Management Board under the Current LTIP.