Report of the Directors
Governance

Remuneration Report

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Executive Remuneration Practices and Rules 2011/12

In 2010/11 a full review of remuneration was carried out, followed by a shareholder consultation in early 2011. The new practices and rules were described in last year’s annual report and are now used in the calculation of variable pay and bonuses for the executive directors.

Remuneration Basis with Effect from 1st April 2011: the Rules as they Stand

Executive directors’ remuneration consists of three principal elements: these being basic pay, annual bonus and a long term incentive plan. The details of these are set out below. Information on pension arrangements for the executive directors is also included in this section.

Basic Salary

The general policy regarding basic salaries has been set out above, indicating that there are a number of determinants in arriving at the basic salary award. These key determinants are described in more detail below.

The first determinant is the performance of the individual executive. Performance is considered against a broad set of parameters including financial, environmental, social and governance issues.

The second factor taken into account is the length of time that the executive director has been in post. For example, where promotion has taken place, the salary may initially be set at a lower level than the outgoing director. This can then give rise to higher than normal salary increases while the director gathers experience and moves towards the job norm.

The third factor is a judgment as to whether the level of basic pay remains competitive and appropriate in the relevant comparator group. For the purposes of benchmarking, the remuneration comparator used by the Committee during 2011/12 for executive directors was drawn from FTSE 100 and 250 industrial and service companies (excluding the oil and financial sectors) with market capitalisation of around £4.8 billion and with over 40% of revenue coming from overseas. Further independent benchmark data was sourced from the Hay Group. Benchmark data are regarded as relevant background information for the Committee, but it is not its policy to set salaries directly in line with that data, or with benchmarks mathematically derived from that data. Basic salary is normally reviewed on 1st August each year.

LTIP

The LTIP is designed to incentivise above average performance and growth over the longer term. Shares allocated under the terms of the LTIP (which also applies to the group’s 900 senior and middle managers) are released on the third anniversary of the allocation date with the release being subject to targets based on compound annual growth in the company’s earnings per share (EPS). Current rules require that to achieve the maximum release of allocated shares, a compound annual growth in underlying EPS of 15% must be achieved over the three year period. The Committee strongly believes that EPS remains the best overall measure of the performance of the group across all strategic goals. The Committee has considered setting broader targets for LTIP in areas such as sustainability and new product development, but is satisfied that the full total of successful and long term focused company activities are best encapsulated in the simple and transparent measure of compound annual growth in EPS over a longer period.

Prior to 2011, the bases for share allocations were 150% of basic annual salary for the Chief Executive and 120% for executive directors. In 2011, in accordance with the review published in the 2011 annual report, share allocations of 175% of basic annual salary for the Chief Executive and 140% of annual salary for executive directors were made. These allocations remain within the LTIP rules, as approved by shareholders at the 2007 Annual General Meeting, which allow for share allocations of up to a maximum of 200% of basic annual salary each year, allowing the Committee to take account of evolution of market practice if required.

The minimum release, of 15% of the allocated shares, requires underlying EPS growth of 6% compound per annum over the three year period. For the maximum release of 100% of the allocation, underlying EPS must have grown by at least 15% compound per annum over the three year performance period. The number of allocated shares released will vary on a straight line basis between these points. There is no retesting of the performance target and so allocations will lapse if underlying EPS growth is less than 6% compound per annum over the three year performance period.

In 2009, following consultation with major shareholders, the Committee approved an adjustment to the performance targets for one year only to reflect the market conditions prevailing at the time of allocation. For the 2009 allocation only, the minimum release, of 15% of the allocation, requires underlying EPS growth of 3% compound per annum over the three year period, with no retesting of the performance target. For the maximum release of 100% of the allocation, underlying EPS must have grown by at least 10% compound per annum over the three year performance period. As a result of this adjustment, the level of award was reduced to 120% of basic annual salary for the Chief Executive and 100% for executive directors for that year. Also in 2009, there was a one-off allocation of 170% of basic salary to the then newly appointed Group Finance Director to ensure close alignment of his objectives with those of shareholders.

Although growth in underlying EPS is the primary financial measure, it is also a key objective of the company to achieve earnings growth only in the context of a good performance on return on invested capital (ROIC). Accordingly, the Committee is required to make an assessment of the group’s ROIC over the performance period to ensure underlying EPS growth has been achieved with ROIC in line with the group’s planned expectations. The Committee may scale back vesting to the extent that ROIC has not developed appropriately.

Annual Bonus

The annual bonus is complementary to the longer term LTIP award and provides a strong incentive for a short term delivery of budget in the relevant year. Whilst the LTIP target encourages business managers and the executive directors to set ambitious three year targets, the annual bonus allows the board to ensure that those plans are properly reflected in stretching but achievable annual budgets. The annual bonus is then based strictly on performance against budget, requiring that the group’s budgeted underlying profit before tax (PBT) is exceeded by 10% to release the maximum payment.

The maximum bonus is set as a percentage of basic salary under the terms of the company’s Executive Compensation Plan. As with the LTIP, this plan applies not only to the executive directors, but to around 200 of the group’s most senior executives.

Annual Bonus Rules

  Bonus
awarded
at threshold
(95% of budget)
(% of salary)
Bonus
awarded
at target
(% of salary)
Bonus
awarded
at 110%
of budget
(maximum
award)
(% of salary)
% of awarded
bonus deferred
Chief Executive 15% 75% 150% 33.3%
Other executive directors 15% 62.5% 125% 20%

Setting the Annual Bonus Target

In order for the annual bonus to provide a strong short term performance incentive, it is key that the budgeted profitability is set at an achievable but demanding target. The board is responsible for agreeing the targeted performance and takes into account the detailed business climate for each operating division of the group. Commercial sensitivity prevents the advance publication of targets, but further information regarding historical performance is available in the following table.

Retrospective Data on Annual Budget Targets

Year Budgeted
underlying PBT
(£ million)
Actual
underlying PBT
(£ million)
% of
budget
Chief
Executive’s
bonus
(% of salary)
Executive
directors’
bonus
(% of salary)
Vara
consensus*
(£ million)
Actual
underlying
PBT growth
2011/12 406.0 426.0 104.9% 111.75% 93.13% 382 23%
*
The Vara consensus referred to is the published data regarding industry analysts’ performance expectations for Johnson Matthey, as expressed at the start of the budget year in question. For example, the consensus for 2011/12 is that published in March 2011.

An annual bonus payment of 75% of basic salary (prevailing at 31st March) is paid to the Chief Executive and 62.5% of basic salary is paid to executive directors if the group meets the annual budget. This bonus may rise on a straight line basis to a maximum 150% of basic salary for the Chief Executive and 125% for executive directors if 110% of budgeted underlying PBT is achieved. Underlying PBT must reach 95% of budget for a minimum bonus of 15% of salary to be payable.

For the Chief Executive, 33.3% of the bonus payable is awarded as shares and deferred for a period of three years. For other executive directors, 20% of the bonus payable is awarded as shares and deferred for three years. The Committee is entitled to claw back the deferred element in cases of misstatement or misconduct or other relevant reason as determined by the Committee.

The Committee retains discretion in awarding annual bonuses and seeks to ensure that the incentive structure for senior management does not raise environmental, social and governance risks by inadvertently motivating irresponsible behaviour. The Committee is fully prepared to utilise this discretion where management has failed to properly address such risks.

Other Benefits

The other benefits available to the executive directors are private medical insurance, a company car and membership of the group’s employee share incentive plans which are open to all employees in the countries in which the group operates such plans.

Service Contracts

The executive directors are employed on contracts subject to one year’s notice at any time. On early termination of their contracts the directors would normally be entitled to 12 months’ salary and benefits. The contracts of service of the executive directors and the terms and conditions of appointment of the non-executive directors are available for inspection at the company’s registered office during normal business hours and at the forthcoming annual general meeting.

Pensions – General Description of Arrangements

The company provides executive directors with membership of its UK HM Revenue & Customs registered occupational pension scheme – the Johnson Matthey Employees Pension Scheme (JMEPS). The benefits provided to executive directors through JMEPS are the same as for all other UK employees, namely a defined benefit retirement pension, dependents’ and life assurance benefits plus a top-up defined contribution account. There have been no significant changes to the JMEPS rules during 2011/12.

The pension earned in respect of service up to 31st March 2010 is based on a member’s final salary at the point of retirement, or earlier date of withdrawal from employment. Pension earned in respect of service from 1st April 2010 is based on the member’s career average revalued earnings. Members are not required to pay contributions to receive these defined benefits. However members may pay voluntary contributions to a supplemental defined contribution account and the company will match any contribution made up to 3% of pensionable pay each year.

Under the provisions of the Finance Act 2004 benefits from a registered pension scheme that exceed the Annual Allowance or Lifetime Allowance will be subject to a tax charge. The Annual Allowance and Lifetime Allowance were reduced to £50,000 and £1.5 million respectively with effect from 6th April 2011. On reaching these thresholds members, including executive directors, are given the option to limit their benefits in JMEPS and receive a cash supplement in lieu of the pension benefit forgone, or to continue accruing benefits in the scheme and pay the tax charge. Any tax liability due is the responsibility of the individual not the company.

Neil Carson and Bill Sandford withdrew from pensionable service on 31st March 2006 and Robert MacLeod withdrew on 31st March 2011. No pensionable service in JMEPS has been accrued by these directors since then and all have received a cash supplement of 25% of basic salary in lieu of the pension benefit forgone. The increase in accrued pension for Messrs Carson and Sandford in the table below is attributable solely to the effect of the increase in their basic salary in 2011/12 on their pension earned before 1st April 2006.

During the year Larry Pentz accrued pension in JMEPS up to the Annual Allowance and elected to cease pension accrual for the remainder of the year in return for a cash supplement of 21% of basic salary.

The supplemental payments received by all executive directors are reflected in the table below.

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