Deloitte analysis revealed today shows that the trend for private equity funded firms to attract top management from the listed sector is likely to continue, with executive compensation reward often worth significantly more. Whilst ultimately market forces may work to close this gap, there is currently little evidence of it.

Bill Cohen, executive remuneration partner at Deloitte comments: “The UK listed sector holds a pool of top international managerial talent who are attractive recruitment targets to private equity funded companies, particularly those operating internationally. The compensation packages on offer present an attractive carrot to executives considering their next move.”

The difference in executive reward between private equity backed and publicly listed companies is demonstrated by Deloitte analysis. This shows that for companies listed on the LSE and AIM between July 2003 to January 2005 (a significant number of which came out of private equity investments), the median share holding of a top full time executive (who was not also getting a share option or other type of employee share scheme award) was 11% of the shares in the company, worth approximately £7m. Generally the shares will have been acquired at a low price and therefore taxed at around 10% (without any social security). In contrast, the median pay (which includes salary, bonus and share scheme awards) of a FTSE 350 top full time executive is around £1.5m. This will nearly always be subject to tax at around 40% together with social security.

Neville Bramwell, tax partner and share reward specialist explains the contrast in reward offerings: “Executives who move to the private sector can expect a significant proportion of compensation to be made up of shares in their new employer.  Initially those shares will not normally have the same value as an equivalent holding in a mature listed company, with a significant stock market value.  However, if the private company does well, the value of its shares may increase exponentially because deals are usually substantially leveraged.  There may be further benefits in the event of a successful float or sale.  Had the same executive remained in the listed sector, their shares might have increased in value but it would be unlikely to be by the same amount.

“Of course, there is a flip side to this: the risk of losing everything is greater in a private company, because where a substantial amount of return is channelled to lenders, there may be nothing left for the holder of ordinary shares.”

Bill Cohen comments: “Executives who want to be rewarded as entrepreneurs, with the possibility of sharing real value gains with other investors, are increasingly drawn to join private companies.  The returns which can potentially be made may well look larger than those in a listed company.  But there is a growing awareness in private equity firms of the contrasting market levels of remuneration in listed companies as compared to privately owned firms. As a result of this, there is an increasing willingness to look at estimates of what final outcomes might mean for managers in value terms and more closely align remuneration packages. 

“Listed company shareholders of course may not wish the top management team to be rewarded as if they were entrepreneurs.  A steady hand on the tiller rather than planning for explosive growth might be more appropriate.  Nevertheless, just as private equity firms may want to look at market levels of remuneration in the listed sector more closely, listed companies may wish to examine whether they can introduce more leveraged forms of share based return for key managers.”

Deloitte believe that those responsible for remuneration policies in both the private and listed sectors can draw on aspects of best practice operated in each.  Some key questions to ask are:

Listed companies

• Is reward leveraged enough to reward very superior performance?
• Can a greater component of reward take the form of shares to which tax efficient taper relief applies?
• Should the benchmarking of reward take account of private equity practice?

Private Companies

• Will emphasis on equity participation for managers lead to divergence from investor interests in some circumstances (e.g. leavers acting as minorities; refinancings which do not benefit ordinary shareholders)?
• Does the fact that equity typically rewards only very strong performance mean that any greater part of overall incentives should be directed to rewarding good but not very outstanding performance?
• Is the expected exit value of equity (plus other benefits) in line with the listed market annual reward over a comparable period (risk adjusted)?

End

Notes to Editors
Shares in a private company can be held on very straightforward terms, free of the performance conditions which are ubiquitous in relation to incentive awards in the listed sector. In fact, some argue that there is confusion over the purpose of share ownership in the listed sector.  Managers’ share incentives are neither a real investment in the company (because of the difficulty of structuring arrangements tax efficiently), nor do they represent real gain sharing with other investors (because the performance conditions weigh against that).

About Deloitte
In this press release references to Deloitte are references to Deloitte & Touche LLP.

Deloitte & Touche LLP is the UK's fastest growing major professional services firm based in 21 UK locations, with over 10,000 staff nationwide and fee income of £1,246 million in 2003/2004. It is a member firm of Deloitte Touche Tohmatsu, a leading professional services organisation, delivering world class audit, tax, consulting and corporate finance services, with around 120,000 people in over 140 countries. Deloitte Touche Tohmatsu is a Swiss Verein, and each of its national practices is a separate and independent legal entity.

Deloitte & Touche LLP is authorised and regulated by the Financial Services Authority.

The information contained in this press release is correct at the time of going to press.