Directors' Report: Governance - British American Tobacco

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