LONDON, United Kingdom — It is not so long ago that the share performances of luxury goods stocks were closely correlated, as strong growth throughout the industry masked differences in individual performance. Over the long term, however, the actual returns for investors within the sector have become more uneven. In other words, some companies — and their investors — are making more money on their investment than others.
This being the case, it would be reasonable if managers were encouraged — and incentivised — to achieve high returns. In fact, this is far from the case. My review of the remuneration policies of twelve leading luxury goods companies found that none has yet tied the variable component of its senior managers’ remuneration to either cash generation, return on invested capital (ROIC) or total shareholder return (TSR), i.e. share price performance plus dividends. (The size of this sample was limited by the number of companies that disclose the relevant information.)
Burberry, Kering and Luxottica have all recently talked about emphasising ROIC, but only Burberry has introduced ROIC as one of the three criteria in its long-term incentive (LTI) scheme. In contrast, at seven luxury companies, CEO bonuses are dependent on sales — at Hermès and Prada, they are entirely dependent on sales.
My findings should come as no surprise. Investors in luxury goods in Europe are often confronted with corporate and shareholding structures designed to give controlling voting rights to founders and their descendants, over and beyond the equity capital they actually own. Investors have to accept a state of affairs where founding family members hold controlling voting rights and key senior management positions in the business.
This is the case at Prada, where chief executive officer Patrizio Bertelli received a fixed salary of €7 million (about $7.58 million) and a bonus and LTI payment amounting to €6.3 million (about $6.82 million). In 2015, his total compensation was equivalent to 4 percent of the Group’s net profit (the average in the luxury sector is 1.2 percent), yet Prada was the sector’s worst performer based on ROIC and TSR. Between 2012 and 2015, Bertelli’s total package increased by 20 percent, while Prada’s ROIC showed the sharpest deterioration in the sector and the company’s share price fell roughly 30 percent.
As a result, senior remuneration is ill-aligned with the interests of shareholders. Total shareholder return is a function of the balance sheet and cash flow over time, which reflect the underlying health and profitability of a company. But senior remuneration tends to reward the profit and loss account, which is subject to non-operating factors.
Where returns-related metrics are used to calculate annual bonuses, their importance is diluted by other factors. For example, Kering includes cash flow as one of two criteria when setting its annual bonus, while LVMH and Richemont include it as one of four criteria. Swatch includes working capital as one of four criteria. Salvatore Ferragamo includes TSR as one of three criteria, while Tod’s includes net debt as one of three criteria.
Longer-term remuneration plans tell a similar story. Tod’s uses TSR, cash from operations and net debt; LVMH uses four criteria, including cash from operations and operating investments; Richemont uses cash from operations as one of three criteria. Ferragamo includes TSR as one of three criteria.
CEO remuneration policies like these are out of date. Most were designed during the boom years of rapid international expansion, diversification and mergers, when using sales growth as the main criterion for bonuses and long-term incentives worked well. But in today’s low-growth world, in which other performance factors are magnified, it is clear that CEO remuneration levels are not supported by results — and give investors little reason to celebrate.
Most companies need to overhaul their senior remuneration policies to better align them with shareholders’ interests. Recognising this opportunity would be a big step towards attracting investors in today’s more subdued growth environment.
Luca Solca is the head of luxury goods at BNP Exane Paribas.