Directors' Report: Governance - British American Tobacco

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www.bat.com/annualreport2009 Since the award made in 2008, the performance schedule has been structured such that the same percentage of salary will vest for threshold performance for Executive Directors and the Management Board as for awards made prior to 2008. This was achieved by reducing the entry level vesting for median ranked performance for each portion of the TSR performance condition from 7.5 per cent to 6 per cent of the award; and reducing the entry level vesting for EPS growth from 10 per cent to 8 per cent of the award. This maintains the positioning of the total remuneration package for ‘target’ performance, and increases the opportunity for higher levels of performance. This approach will also apply to the LTIP award to be made in 2010. Since 2005, participants have been entitled to receive a dividend equivalent payment to the value of the dividends that they would have received as shareholders on their vesting awards. The LTIP dividend equivalent payment continues to be important in aligning further the interests of senior management with those of shareholders. The values of the LTIP dividend equivalent payments for the Executive Directors are shown as individual emoluments in Tables 3 and 4. To the extent that the performance conditions have been satisfied following assessment by the Remuneration Committee, awards are normally exercisable between three and 10 years after they have been made. An award of shares lapses to the extent that the performance conditions are not satisfied in accordance with the measures set out above at the end of the three year performance period. Further, any such proportion of the award that lapses as a result does not attract the payment of the LTIP dividend equivalent payment. Performance The percentage of award vesting is based on a combination of TSR and earnings per share (EPS) performance conditions measured over a three year period. The Remuneration Committee considers that both of these measures are appropriate benchmarks of a company’s performance. This combination provides an important balance of measures relevant to the Group’s business and market conditions as well as providing a common goal for the Executive Directors, the Management Board members and shareholders. These performance conditions are set out in the above table and are considered in more detail below. TSR performance condition A total of 50 per cent of the total award is based on the Company’s TSR performance against two comparator groups (25 per cent for each measure): (1) the constituents of the London Stock Exchange’s FTSE 100 Index at the beginning of the performance period; and (2) a peer group of international FMCG companies. In the event of upper quartile performance by the Company relative to the comparator groups above, 25 per cent of the total award vests in full. From 2008, 6 per cent of the total award vests for median performance (7.5 per cent for the 2006 and 2007 awards). There is pro rata vesting between these two points. The TSR portions of an LTIP award do not vest for below median performance. Directors’ report: Governance British American Tobacco Annual Report 2009 These comparator groups, which are regularly reviewed to ensure that they will remain both relevant and representative, are chosen to reflect the Company’s financial and business trading environments. The applicable FMCG peer groups for the outstanding LTIP awards are shown below. Award: Award: Award: 27 March 15 May 15 May FMCG Peer Group 2009 2008 2007 Altadis ✓ Altria Group1 ✓ Anheuser-Busch ✓ ✓ Anheuser-Busch InBev ✓ Cadbury ✓ Cadbury Schweppes ✓ ✓ Campbell Soup ✓ ✓ ✓ Carlsberg ✓ ✓ ✓ Coca-Cola ✓ ✓ ✓ Colgate-Palmolive ✓ ✓ ✓ Danone (formerly Group Danone) ✓ ✓ ✓ Diageo ✓ ✓ ✓ The Gillette Company ✓ ✓ Heineken ✓ ✓ ✓ HJ Heinz ✓ ✓ ✓ Imperial Tobacco Group ✓ ✓ ✓ InBev SA ✓ ✓ Japan Tobacco ✓ ✓ ✓ Johnson & Johnson ✓ ✓ ✓ Kellogg ✓ ✓ ✓ Kimberly-Clark ✓ ✓ ✓ LVMH ✓ ✓ ✓ Nestle ✓ ✓ ✓ PepsiCo ✓ ✓ ✓ Pernod Ricard ✓ ✓ ✓ Philip Morris International1 ✓ ✓ Procter & Gamble ✓ ✓ ✓ Reckitt Bencksier ✓ ✓ ✓ SABMiller ✓ ✓ ✓ Sara Lee ✓ ✓ ✓ Scottish & Newcastle ✓ Unilever ✓ ✓ ✓ Wrigley ✓ ✓ Note: 1 Altria Group was tracked until the demerger of Philip Morris International on 17 March 2008, and a market cap weighted basket of Philip Morris International and Altria Group is tracked from March 2008. For the 2008 award, Philip Morris International is tracked from the point of the demerger. TSR continues to be measured according to the return index calculated by Datastream and reviewed by the Company’s independent advisers. It is measured on the basis that all companies’ dividends are reinvested in the shares of those companies. The return is the percentage increase 83 From the Chairman Performance and strategy Regional review Financial review Governance Group financial statements Parent Company financial statements Shareholder information
in each company’s index over the three year performance period. The opening and closing indices for this calculation are respectively the average of the index numbers for the last quarter preceding the performance period and for the last quarter of the final year of that performance period – this methodology is employed to reflect movements of the indices over that time as accurately as possible. A local currency basis is used for the purposes of TSR measurement. This approach is considered to have the benefits of simplicity and directness of comparison with the performance of the comparator companies, and is in line with the historic approach taken by the Remuneration Committee for the purposes of TSR measurement. EPS performance condition Half of the award is based on earnings per share growth relative to inflation. This element of the award will vest in full if EPS growth over the three year performance period is an average of at least 8 per cent per annum in excess of inflation. Ten per cent of this element of the award (8 per cent for awards made since 2008) will vest if the EPS growth over the performance period is 3 per cent in excess of inflation. An award will vest on a pro rata basis between these two points. None of the EPS portion of an award vests if EPS growth is less than 3 per cent per annum in excess of inflation. These EPS targets are consistent with and support the Company’s strategy to deliver high single-digit EPS growth (on average) over the medium to long term and are considered to be very demanding. The Remuneration Committee keeps the targets under review to ensure that they continue to be appropriately stretching. For awards made up to and including 2008, growth in EPS for these purposes is calculated on an adjusted diluted EPS basis using a formula which incorporates: (1) the adjusted diluted EPS for the year prior to the start of the first performance period and then for the first, second and third years of that performance period; and (2) retail price index (RPI) for the last month of the year immediately preceding the performance period and then the RPI for the respective first, second and third years of that performance period. In 2009, the Remuneration Committee, following discussion with key shareholders, moved to a more standard approach for calculating EPS growth. Commencing with the LTIP award made on 27 March 2009, EPS performance is measured as an increase in adjusted diluted EPS between the base year and the final year of the performance period, expressed as an annual growth rate over the period. Under this approach, only the base year and final year adjusted diluted EPS results are considered. However, on the basis that rolling annual awards are made, all years of performance ultimately will be taken into account in calculating EPS growth over time. This change was made in order to simplify the approach and to bring it into line with prevailing market practice. Where EPS grows at a relatively constant rate, the two methodologies will produce broadly similar results, although the outcome will differ for different growth profiles. REMUNERATION REPORT CONTINUED Both the previous approach and the new method of calculation introduced in 2009 are considered to be fair and reasonable measures of performance. Vesting of LTIP award made in 2007 An LTIP award was made to Executive Directors and Management Board members on 15 May 2007 with the performance period being completed at 31 December 2009 (the 2007 Award). The Remuneration Committee has assessed the performance of the Company against the two performance conditions. On the TSR measure, the Company ranked eighth out of the FTSE 100 group of companies, giving a vesting of 25 per cent for performance at the upper quartile. A vesting of 25 per cent was also achieved for ranking second out of the peer group of international FMCG companies, this also being upper quartile. EPS growth was 12.1 per cent per annum in excess of inflation. The overall assessment of both LTIP measures, therefore resulted in a vesting of 100 per cent of the award. As performance is based on the three year period to the end of December 2009 and it is therefore known what percentage of the award will vest, the Board has considered taking steps to enable the participants to elect to be taxed on these awards in the 2009/10 tax year. The majority of the LTIP population is not affected as their awards will vest in March 2010. As a result, the Company has agreed to offer the Executive Directors and certain Management Board members who are impacted the opportunity to enter into restricted share agreements in March 2010. Consequently, where a participant elects to receive the beneficial interest in the shares underlying the respective 2007 Awards (to the extent that the performance conditions have been met), the shares will continue to be held on behalf of the participants by the trustee of the British American Tobacco Group Employee Trust. Until the third anniversary of the date of grant (15 May 2010) the shares will continue to be subject to forfeiture/clawback, in particular in circumstances of leaving the Company, and any shares that would not have vested under the rules of the 2007 LTIP will be forfeited for no consideration. Shares in which the beneficial interest only is transferred cannot be sold until the third anniversary of the making of the award and, in particular, none of the shares being transferred may be sold to cover the taxation and other statutory withholding obligations arising on the transfer of the beneficial interest in the shares. Each participant will pay their respective liabilities to the Company from their own funds. These arrangements are cost neutral to the Company and will not have an impact on the Company’s corporation tax deduction treatment for LTIP exercises. In accordance with the rules of the 2007 LTIP, the Remuneration Committee also resolved that the participants would be paid an amount equivalent to the dividends that they would have received over the period from the date the awards were made to the date they entered into their restricted share agreements. In the event that such dividend payments would not have been paid on the normal vesting date, participants have agreed to repay such amounts to the Company. 84 British American Tobacco Annual Report 2009 Directors’ report: Governance
Page 1 and 2: GOVERNANCE Board of Directors A sum
Page 3 and 4: 1. Richard Burrows (Irish) Chairman
Page 5 and 6: CONTENTS Chairman’s introduction
Page 7 and 8: meeting to address Jan du Plessis
Page 9 and 10: The Board and its Committees receiv
Page 11 and 12: Accountability and audit Audit Comm
Page 13 and 14: The Audit Committee has an establis
Page 15 and 16: Corporate social responsibility CSR
Page 17 and 18: Appointments to the Board Nominatio
Page 19 and 20: CONTENTS Introduction 78 Remunerati
Page 21 and 22: The Remuneration Committee reviewed
Page 23: For the Executive Directors and Man
Page 27 and 28: The Company also operates the Free
Page 29 and 30: Executive Directors’ external app
Page 31 and 32: Appendices to the Remuneration repo
Page 33 and 34: REMUNERATION REPORT CONTINUED Table
Page 39 and 40: CONTENTS Companies Act 2006 98 Prin
Page 41 and 42: Articles of Association The followi
Page 43 and 44: 2) a Director to accept or continue
Page 45 and 46: The Disclosure and Transparency Rul
Page 47: 106 British American Tobacco Annual

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