Pay attention

AT THE height of his career at Vinci, a French construction giant, Antoine Zacharias, its chairman, had a salary of several millions, a lavish pension and stock options worth €250m. On one occasion the French financial police visited Vinci's headquarters to investigate the firm's purchase of furniture for a luxurious Paris townhouse bought for his use. In 2006 Mr Zacharias was forced out and left with a generous severance package, but he sued the company for €81m for allegedly preventing him from exercising some stock options. The case, notorious in France, was finally closed two weeks ago when a court ruled against him.

Bosses in Europe should take heed. Even when performance is outstanding—Vinci's shares went up ninefold during Mr Zacharias's nine years at the top of the firm, and its revenues more than tripled, to €26 billion ($33 billion)—opinion has turned squarely against big pay packages. Jean-Claude Juncker, president of the European Commission's “Eurogroup” of finance ministers, recently called excessive pay a “social scourge” and demanded action. When L'Expansion, a French business magazine, calculated that pay for the country's bosses went up 58% in 2007, the finance minister, Christine Lagarde, said it was “scandalous” and threatened regulation. Nicolas Sarkozy, president of France, and Horst Köhler, president of Germany, have also denounced high pay.

“If we go into a major recession with job losses, but top executives are still being paid huge sums, that's bad for the reputation of capitalism,” says Peter Montagnon, director of investment affairs at the Association of British Insurers. Banks in particular have come in for criticism. Not only are they blamed for the credit crunch, but some, such as Switzerland's UBS, have admitted that the way in which they rewarded senior employees led them to take greater risks, resulting in huge losses on subprime mortgages.

Already in the Netherlands new legislation on executive pay is making its way through parliament. The law would set €500,000 as the level of annual salary or severance payment at which extra taxes must be paid. Germany's Social Democratic Party is pushing for legislation to clamp down on pay, though its partner in government, Angela Merkel's Christian Democratic Union, has so far resisted. And the European Commission is working on a response to the Eurogroup's complaint.

How excessive is bosses' pay in Europe? It has certainly risen sharply in the past ten years, as European firms have had to compete globally for talent. Foreign bosses now run seven of the firms in France's CAC 40 index and five of Germany's DAX 30. American-style bonuses and long-term incentive plans are now the norm.

European firms now benchmark pay against international peer groups in their own industries, rather than against domestic rivals, according to Piia Pilv, a pay expert at Mercer, a consultancy. But they still pay a fraction of the sums trousered each year by American executives. According to Hay Group, a management consultancy, the median European executive earns just 40% as much as his equivalent in America (see chart).

Most importantly, European companies appear to be more determined than American ones to link pay to performance. “Firms in Europe have tended to put more stringent conditions on long-term incentive awards than in America,” says Richard Bednarek, global director of executive remuneration for Hay Group. In America grants of shares are often not tied to performance, whereas European firms generally attach performance criteria to any grant of shares, typically depending on a comparison with a peer group. Such schemes often do not pay out at all, says Mr Bednarek. Dan Vasella, boss of Novartis, a Swiss pharmaceutical giant, and a favourite target of pay activists, earned SFr17m ($14m) in 2007, down 33% from 2006, because he missed his targets.

Last year France introduced a new measure, unheard of elsewhere, which makes severance payments conditional on performance. Usually only bonuses and long-term incentive plans are tied to results. At the end of May, to comply with the law, Alcatel-Lucent, a maker of telecoms gear, changed its contract with its chief executive, Patricia Russo. If she leaves or is fired after January 2009, she will get her severance money only if the firm achieves 90% of its revenue target or 75% of its operating-profit target during the period. Remuneration consultants complain that the law could make it harder for companies to get rid of underperforming chief executives. But it is undeserved “golden parachutes” that enrage public opinion the most, and the government wants to stamp them out.

Big differences in pay persist between European markets. Companies in Scandinavian countries and in the Netherlands, which are particularly egalitarian, usually pay less than French, German or British firms. Britain and France make use of stock options, whereas firms elsewhere prefer to give “free” shares. Use of stock options, never so widespread in Europe as in America, is in fact declining in most countries. Another trend is for publicly listed firms to copy private equity's pay structure, to avoid losing the best people, according to Mercer. Executives make a big private investment in the firm, but gain many multiples of their annual salary if they meet extremely high performance criteria.

Few shareholders are unhappy with the increase in executive pay in Europe, says Jean-Nicolas Caprasse, head of European corporate-governance research at RiskMetrics Group, which advises institutions on how to vote at annual general meetings. They are gradually winning more say over pay deals, as in America (see article). By law in the Netherlands, Sweden and Norway, shareholders get a binding vote on compensation packages; in Britain they get a non-binding vote. Some Spanish and Swiss firms are voluntarily starting to offer shareholders a vote.

In Britain, where “say on pay” has been in place since 2004, says Mr Montagnon, shareholders now have a far better understanding of the structure of executive pay packages and their link with performance. “But nothing stops the volume of payments, and the amounts seem to rise inexorably,” he says. It is near impossible, of course, to determine the correct absolute level of executive pay. Shareholders will find it hard to prevent headline-grabbing paydays, even if they wanted to. So expect further political outrage, and more red-faced bosses coming under fire.