The financial statements of Rolls-Royce plc (aero engine manufacturer) for the year ended 31 December 1999 disclose the following matters in relation to the directors:

(a) Remuneration committee The remuneration committee, which operates within agreed terms of reference, has responsibility for making recommendations to the board on the Group’s general policy towards executive remuneration. The committee also determines, on the board’s behalf, the specific remuneration packages of the executive directors and a number of senior executives.

The membership of the committee consists exclusively of independent non-executive directors

(the financial statements disclose the names of these directors). The committee meets regularly and has access to professional advice from inside and outside the Company.

The Chairman of the Company (a par t-time executive director) and the Chief Executive (an executive director) generally attend meetings but are not present during any discussion of their own emoluments.

(b) Base salary The committee believes that in order to attract and retain executive directors of the right calibre and to provide them with adequate incentives to deliver the Group’s objectives, the Group should pursue a policy of offering median-level base salaries for its executive directors, and through the per formance-related schemes, the oppor tunity of upper quar tile earnings for upper quar tile per formance.

(c) Annual performance award scheme The scheme enables a maximum per formance award of up to 60% of salar y to be paid to executive directors for exceptional per formance against pre-determined targets based upon return on capital employed with a tapered and reducing scale of maximum percentages for senior employees. The targets are set by the committee based upon the Group’s annual operating plans. Such payments do not form par t of pensionable earnings. One-third of total awards made are paid in Rolls-Royce shares which are held in trust for two years, with release normally being conditional on the individual remaining in the Group’s employment until the end of the period. The required shares are purchased on the open market. This arrangement provides a strong link between per formance and remuneration and provides a culture of share ownership amongst the Group’s senior management.

(d) Long-term incentive plan The LTIP involves the grant of awards of shares in the Company, which can be realised in the form of shares and cash if demanding per formance targets are met. The maximum value of the awards is 60% of salar y for executive directors, with a tapered and reducing scale of maximum percentages for senior executives. The required shares for the LTIP are purchased on the open market.

The percentage of the award, and therefore the value which can be realised, depends upon the Company’s total shareholder return (TSR) over a three-year per formance measurement period, compared to that achieved over the same period by a group of 19 comparator companies comprising other leading engineering and industrial companies. No award is realised unless the average growth in the Group’s EPS over the three-year period is at least 2% per annum greater than the average increase in the UK retail price index over the same period.

Under the rules of the LTIP, the percentage of shares comprised in the award which can be realised is determined by the Company’s TSR ranking against the comparator group. 100% of the award is secured for a first, second or third ranking with a uniform sliding scale of percentages then being applied to each ranking down to, and including, ninth place which earns 40% of the share award. No award is made if the Company’s TSR ranking is tenth or below. If an award is realised, the par ticipant receives one-half of its value at the release date in the form of shares and the other half in cash. He or she is required to retain at least half of the shares for a minimum of two years.
The per formance period for the 1997 LTIP grant ended on 31 December, 1999 and no award was realised.

(e) Service contracts In the light of the Combined Code (which recommends rolling contracts of no more than one year), the committee has reviewed its previous policy of offering UK executive directors two-year rolling contracts. It has concluded that new appointees to the board will be offered notice periods of one year. The committee recognises that in the case of appointments to the board from outside the Company, it may be necessar y to offer a longer initial notice period, which would be subsequently reduced to twelve months after that initial period. Five executive directors (which the repor t names) all have two-year rolling contracts, which provide for 24 months’
notice in the event of termination of employment by the company. These contracts were entered into before the change in policy described above.

(f) Compensation and mitigation The committee has a defined policy on compensation and mitigation to be applied in the event of a director’s contract being permanently terminated. In these circumstances, steps are taken to ensure that poor per formance is not rewarded. When calculating termination payments, the committee takes into account a range of factors such as age, years of ser vice and the director’s obligation to mitigate his own loss.
A director (named in the accounts) retired early from the Company on 31 December 1999 and received a termination payment of £530,000 and a payment of £20,298 in lieu of benefits. The committee considered this compensation in the light of its policy on mitigation and in line with that policy concluded that it would not be appropriate to apply mitigation.
The accounts disclose the retiring director’s base salar y for the year ended 31 December 1999 was £240,000.
For the retiring director, there was no disclosure of:
(i) his age at 31 December 1999, (ii) his executive position in the company, and (iii) the reasons why he took early retirement.
The financial statements did disclose the executive position and age of the other directors at 31 December 1999.
There were no exceptional points included in the financial statements about directors’ pensions. Items included in italics in the text above are comments or additional information provided by the author.
Required:
Comment on the notes to the financial statements included above.