28 January 2012 Last updated at 06:50 ET

Article written by Robert Peston Business editor

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RBS chairman gives up £1.4m shares reward

 

Earlier this month I mentioned that Royal Bank of Scotland's chairman Sir Philip Hampton was entitled to receive 5.17m shares in the bank later this year.

These would have been worth £1.4m at the current RBS share price.

As I understand it, Sir Philip decided - before the great furore over chief executive Stephen Hester's bonus blew up - that it would not be appropriate to receive these shares, and told the bank's remuneration committee as much. So on Wednesday, the remuneration committee agreed to his wishes.

Sir Philip won't be receiving the £1.4m in shares.

If the chairman decided to give up what's known as his "restricted share award", worth well over a million pounds, why didn't the chief executive, Stephen Hester, sacrifice his bonus of just under a million pounds?

Well, the additional reward for Sir Philip was always something slightly unusual, which - as it happens - he didn't request when he took the job three years ago. This shares incentive had already been agreed in negotiations with another candidate to chair RBS (Lord Davies, the former Standard Chartered chief executive, who ultimately turned the job down), and Sir Philip just attached his moniker to a contract drafted for someone else.

By contrast, for most chief executives of British PLCs, and not just for Stephen Hester and bankers, the bonus is broadly seen as an entitlement, not really a reward for exceptional performance.

So in Mr Hester's very small world of internationally mobile bankers and executives, it would have been a bitter humiliation to be awarded a zero bonus - a public statement by the bank that he had failed.

As it is, the bank's non-executives were concerned by how he would feel about being awarded 60% of his maximum entitlement, which he has been allotted, since they feared he would see this as a slap in the face.

You may regard that as astonishing, given that he has a basic salary of £1.2m and may yet be awarded a multiple of that salary in his long-term incentive plan (see my earlier note, for more on this). But don't under-estimate the huge and widening gap between what's perceived as normal in the boardroom and what's seen as acceptable elsewhere.

Here is the central dilemma for government ministers and for Royal Bank of Scotland's board: Stephen Hester agreed to become chief executive of the bank in 2008 as a commercial job in the commercial sector, not as a public-servant on civil-service pay; and they fear it would be impossible to find a qualified person to do the job on a remuneration package more appropriate to the public sector.

And this is not just an unresearched, self-justifying concern. RBS's board has investigated how easy it would be to find a replacement for Mr Hester willing to take much lower pay. It has to do this on an ongoing basis as part of normal succession planning. And the stark message from the headhunters is that no obvious candidates come to mind.

The size of Stephen Hester's share bonus has created controversy this week

Of course the headhunters themselves have a financial incentive to provide this answer - since they get a commission from recruiting senior directors, and are therefore on board the big-pay gravy train.

But they're probably right that the field of available candidates is tiny, not least because - since the great crash of 2007-8 - the Financial Services Authority has set the bar much higher in respect of the qualifications and experience required of a chief executive of a big international bank (the FSA's approval is required for any senior bank appointment).

The knowledge and talents required of someone running a bank as huge and complicated as RBS are not possessed by many. In the case of RBS, the chief executive has to understand not only how to run a retail bank but also how to contain the risks of all those complex derivatives that are created and traded by the investment bank.

Frankly it would be little short of astonishing if even Mr Hester, with his background in investment banking, understood everything that RBS gets up to around the world. Finding someone better qualified to manage and contain these risks would not be easy.

All that said, you might think that the collapse in the bank's share price over the past year would have been more than enough justification to withhold the bonus. But share-price performance is not a formal factor that the board's remuneration committee is supposed to take into account when deciding bonuses - because to do so would give too great an incentive to the chief executive to take dangerous short-term risks to temporarily boost the share price.

Instead, according to the bank's remuneration report, the bonus is decided on "strategic direction; business delivery and financial performance; stakeholders (including delivery against UK government lending commitments); risk and control; and capability and development".

Now RBS has failed to hit the so-called "stretch" targets for lending to small businesses, agreed with the Treasury in Project Merlin, by a modest margin. And as the biggest lender in the UK to small businesses by a wide margin, this matters.

But RBS's remuneration committee would argue that the reduced bonus reflects this failure. It would also say that Mr Hester is succeeding in putting the bank on much more solid foundations, which was the imperative after the taxpayer was forced to rescue it in the autumn of 2008 - and that there was progress in that respect last year, notably a massive reduction in the amount that RBS lends and borrows.

To state the bloomin' obvious, Mr Hester could have turned the bonus down. But he would point out - and his fellow directors would agree - that he is already in the bottom quartile, and probably in the bottom decile, in respect of the pay, bonuses and other longer-term incentives he receives for managing a bank of RBS's size, international spread and complexity.

His basic salary of £1.2m may look more than adequate to most people. But in his world, which is not the world occupied by most people, it is the trimmings around the basic pay - the bonus scheme and the long-term incentive plan - that are the real and substantial remuneration meal.