QUALIPORT
Are Your Shares Run By Fat Cats?

By Maynard Paton (TMFMayn)
January 28, 2002

Rochester, Kent -- The tabloids love stories about corporate 'fat cats'. But for prudent shareholders, those directors who cream off a company's profits for their own benefit should be given a wide berth. Too much boardroom pay, with too little corporate progress, can signify a company run without its shareholders in mind.

But how can you tell whether a company is actually run by a fat cat?

Like most things to do with investment, there's no clear-cut answer. Shareholders have to take a number of factors into account and make comparisons with other company boardrooms. Needless to say, a fair amount of judgement is required.

However, there are three basic points to look for.

* Shareholdings: There's no better way of identifying a shareholder-aligned director than by looking at his personal holding in the company.

* Basic Pay: Too much in the way of basic pay, when taking into account the company's profits and size, can signal management not having shareholder value in mind.

* Bonuses:Where the recent corporate performance has been average or worse, large bonuses are another sign of a shareholder-unfriendly boardroom.

With those points in mind, how do the sixteen companies on the Qualiport's watch list square up?

Company              Pre-tax   Boardroom   Boardroom  Boardroom
                      Profit   Investment  Basic Pay   Bonuses
                        (£m)      (£m)       (£k)        (£k)



Lloyds TSB             4,110      11.9       3,543      1,009 
Imperial Tobacco         502       4.1       1,427        716
Allied Domecq            453       1.6       2,190      2,047
Emap                     197       8.9       1,452        115
Johnston Press            68      81.4         955        161
London Stock Exchange     67       1.1       1,290        968
SSL International         62       0.8       1,622          0
Halma                     50      24.1       1,013        172
Carpetright               44     100.1         917        170
PizzaExpress              40       5.3         780        831
Renishaw                  31     153.0         899        444
Ultraframe                26      72.4         669          0
Ulster Television         14       1.0         292        412
Games Workshop            11      13.0         461         52
Metal Bulletin             8       1.2         442         98
Latchways                  3       2.9         326          0

Although the table excludes share options, the figures do highlight areas for further inspection: Allied Domecq (LSE: ALLD), the London Stock Exchange (LSE: LSE) and SSL International (LSE: SSL). While the LSE and SSL have had their costs boosted by ex-directors and various payoffs, Allied's boardroom is perhaps worthy of most investigation.

Big bonus

Allied Domecq's top-level management received a £2m bonus in 2001, an amount virtually equal to their aggregate basic pay. Looking at the group's latest annual report, the performance-related bonus "is equivalent to 7% of a director's annual basic salary for every 1% real growth in earnings per share (EPS)". 

Allied's latest annual report stated 2001 EPS increased by 13% to 31.0p. However, given that Allied's management has been improving group EPS through acquisitions, is their bonus scheme really appropriate? Unfortunately, Allied make no reference to return on equity measures, which would be far more suitable as a basis for bonus incentives.

That said, a look through the annual reports of the other 15 watch list companies suggests Allied is far from alone with its EPS focus.

For instance, Johnston Press (LSE: JPR) only states its boardroom bonuses are based on "an increase in EPS set by the Board". Metal Bulletin (LSE: MTLB) is similarly vague, declaring "bonus provisions are exclusively related to annual growth in profits". Bonuses at PizzaExpress (LSE: PIZ) were "based upon budget group pre-taxation earnings per share" for 2001. Only Halma (LSE: HLMA) and Lloyds TSB (LSE: LLOY) make any reference to return on capital measures in their incentive schemes.

Clear and demanding

Overall, too many companies (Qualiport worthy or not) declare vague profit-based cash bonus schemes. In addition, too many companies operate dilutive share option schemes that employ undemanding benchmarks. Certainly a lot of improvements can be made in the general reporting of bonus schemes and the hurdles used.

And given the general popularity of lacklustre performance hurdles and share option schemes, it could pay investors to forget about specifically looking for fat cat management. Alternatively, investors should do better by simply hunting for those businesses whose boardroom pay isn't obviously excessive, and whose bonus hurdles are clear, demanding and in line with ordinary shareholders' interests. Here are three good examples:

Renishaw (LSE: RSW) operates an annual 'appreciation award' that is "based upon group profits and the achievement of a number of strategic investments to maintain the long-term development of the Group".

Although no performance hurdles are defined, at least Renishaw shareholders won't suffer any dilution in their holdings -- Renishaw is almost unique amongst listed companies in that it doesn't operate a share option scheme. The group's bonuses are all accounted for in that year's profits, making life clear and simple for performance analysis.

Meanwhile, Carpetright (LSE: CPR) has recently "taken the decision to change from its existing share option scheme to a cash reward scheme to avoid diluting existing shareholders' holdings." The payment hurdle for the new scheme used is clear too. If cumulative pre-tax profits exceed £190m over the next three years, the board and senior managers will share a £2.3m cash bonus.

Finally, Games Workshop (LSE: GAW) has imposed some rigorous benchmarks for its chief executive, Tom Kirby. Kirby will get a £250,000 cash bonus only if Games Workshop's EPS "increases by at least a cumulative rate of 15% per annum" between 2000 and 2003. Furthermore, his bonus is improved by £2,000 for every penny the share price has increased during that time.

The author owns shares in Carpetright, Games Workshop, Johnston Press and Latchways.