Ellason lens on… Inflation: Considerations for FY22 bonuses

Tue 06, September

Inflation is spiking, and is at exceptionally high levels. In this first Ellason Lens of a special series focusing on inflation’s impact on remuneration, we consider the possible impact on FY22 annual bonus outcomes.

How exceptional is the current level of inflation?

You have to go back 32 years to the 1990s to see anything close to the levels we are experiencing today (see chart, below). The annualised inflation rate (i.e. the % which is discussed in the media) is currently 12.3% and has averaged 10.3% during 2022 (which statistics, using standard deviations and assuming a normal distribution, would tell us would be expected to occur in only 3 years in every 1,000).

Will it continue?

Inflation is forecast to reduce in 2023, but still remain historically high at 4.9% and then return to 3.6% in 2024 (source: ONS), similar to the levels we have observed in the 10 years leading up to the start of the spike (inflation averaged 2.8% during the 2010s). High inflation is the nemesis to a strong economy, with expectations for UK GDP growth now declining to 3.6% in 2022 and pretty much flat (0.6%) in 2023.

Is high inflation built into bonus targets?

Inflation went above the 10-year average for the first time in April 2021 following the economic bounce-back after the easing of lockdown restrictions as a result of the Covid-19 pandemic, and then continued its upwards trend following the invasion by Russia of Ukraine in early 2022. Consequently, some companies may have already built into their bonus targets for FY22 an expectation that inflation will be significant. Even so, the majority of companies with December year ends (covering 55% of the FTSE350) will likely have set their 2022 bonus targets by the end of January 2022, when inflation was ‘only’ at 7.8% (compared to 12.3% now).

Will it have an impact on FY22 bonus outcomes?

We expect the inflation spike will have a negative impact on profits for many companies, because it is predominantly a result of supply chain constraints rather than growth in demand. Our analysis suggests that FY22 earnings forecasts for c.50% of the FTSE350 are now lower than they were 12 months ago, with a reduction of more than 10% expected by analysts for around one-third of the FTSE350 (see chart below). Consequently, in terms of bonus outcomes (for which the most common metric is some measure of profit), outcomes in FY22 may again be lower than the long run average, similar to FY20 when another significant uncontrollable event (the Covid-19 pandemic) had a material negative impact on company performance and on bonus outcomes (38% of the FTSE350 paid no bonus to CEOs in FY20, compared to 11% on average over the previous five years).

Will the impact of inflation be offset by an opposite impact elsewhere?

Possibly. Companies with significant overseas operations may benefit from a foreign exchange tailwind during this period. The UK inflation rate is tracking higher than many other developed nations and this is currently having a negative effect on the value of Sterling (e.g. this has dropped by 12% against the US Dollar in the last 12 months), boosting the Sterling-based earnings from operations in other currencies. Depending on the materiality of this impact, this may offset any impact from cost inflation.

Is it appropriate to make an adjustment to reduce the impact of inflation on bonus outcomes?

Many companies prefer not to make adjustments to bonus targets, to ensure consistency of principles over time. Furthermore, for many companies the use of a scorecard may help mitigate the impact on the bonus pay-out of inflation on any one (financial) measure; for companies where bonuses are based only on one or two measures, there may be justification for considering some adjustment to help ensure credibility in the incentive.

However, any adjustment will need to be considered very carefully in the context of overall pay outcomes and the wider stakeholder experience; in particular the workforce (which is likely to be materially impacted by ongoing cost of living pressures) and shareholders. This is expected to remain a lightning rod for the governance community (and media generally) in 2023, with cautionary notes already being sounded in Ellason’s conversations with key stakeholders (note: the major proxy agencies have informed us that they will be publishing their formal guidance on this issue later in 2022). The brevity of our Ellason Lens format precludes a comprehensive discussion around the nuances of all the relevant considerations for making discretionary adjustments, so we shall be covering these in a forthcoming webinar on general target setting.

What if the impact is positive?

Not all companies are suffering from the price inflation; as our readers will no doubt expect, those companies in the top green bar above (i.e. forecasts are now >30% higher) are predominantly those in the energy sectors. Remuneration Committees at these companies will need to consider whether bonus outcomes for FY22 need adjusting downwards if outcomes have benefited from a significant unexpected tailwind. A recent example is Centrica, where the Remuneration Committee and management agreed that a reduction to the FY21 bonus was appropriate to reflect the “uplift from higher commodity prices”.


Given the continued high level of inflation during 2022 we shall be covering other implications for remuneration in future editions of our Ellason Lens and webinars. Please do not hesitate to contact any of the Ellason team should you wish to discuss this issue further.