Personnel Committee Report

Relevant background Reuben Mark chairs the personnel committee; the other member of the committee is Terry Burns. Both are non-executive directors. Responsibility for servicing the committee rests with David Bell, the director for people, and the committee has regular access to independent advice. Dennis Stevenson and Marjorie Scardino attend unless their own personal positions are being discussed.

It is named the personnel committee rather than the more conventional remuneration committee to underline the fact that, while a major part of its responsibility is concerned with remuneration, its overriding brief in an unusually people dependent company is to help Pearson achieve its goal of being the best employer in the world.

The main roles of the committee are to :

• approve the pay and benefits packages of the executive directors, the chief executives of the main operating companies and other members of the Pearson Management Committee;
• recommend the chairman’s remuneration to the board;
• review the company’s management development, training and succession plans;
• monitor the operation of Pearson’s reward programmes.

Widespread employee ownership is central to the committee’s philosophy. Considerable progress has been made in the last five years in increasing the number of our people who own shares or are saving to acquire them:

• the company operates a profit sharing plan under which all employees (except executive directors) can, at the discretion of the board, receive a cash bonus and Pearson shares based on the company’s overall profitability in addition to anything they might receive under their own companies’ plans;
• for the past four years all employees worldwide have been able to acquire shares through a savings contract linked to a share plan;
• the company also has a significant proportion of our people receiving awards under discretionary equity-based incentive plans with over 3,000 participating this year compared with 185 in 1996.

Compliance The Financial Services Authority requires companies to comply with the provisions of the Combined Code on corporate governance. The committee has considered the provisions in Schedule A of the Combined Code on the design of performance-related remuneration. We believe that the company has complied throughout the year.

Explanation of the company’s remuneration policy We set out below the company’s policies for each of the main elements of remuneration, namely:

• base salary;
• annual bonus;
• annual bonus share matching;
• equity-based incentives.

Base salary Our aim is that base salaries should be set at levels which are competitive with those of directors and executives in similar positions in comparable companies. We monitor this through the use of independent surveys.

Table 1 of this report shows the base salaries for the executive directors following the increases effective from 1 January 2001.

Although the current salaries of the executive directors are not in all cases in line with those of their competitors, the executive directors (along with their fellow senior managers) decided not to receive an increase in their base salaries with effect from 1 January 2002.

Annual bonus The maximum bonus that can be earned by executive directors, chief executives of the company’s main operating companies and other members of the Pearson Management Committee is 100% of annual base salary. Maximum bonus for other senior executives ranges downward from this level. Receiving the maximum requires the achievement of very stretching financial targets set by the committee.

The targets for 2001 related to growth in underlying sales and adjusted earnings per share (on both a pre- and post-internet basis) and trading cash conversion. Performance is measured separately for each item. Although the executive directors were entitled to a bonus of 30% of salary based on the company’s trading cash conversion performance, they elected not to receive a bonus this year.

The committee will continue to review the bonus plans on an annual basis and to revise the bonus limits and targets in the light of the current conditions. The committee does, from time to time, award individual discretionary bonuses but none were awarded for 2001. Bonuses do not form part of pensionable earnings.

Annual bonus share matching The annual bonus share matching plan permits executive directors and senior executives around the Group to take up to 50% of any after tax annual bonus in the form of Pearson shares. If these shares are held – and the company’s adjusted earnings per share increases in real terms by at least 3% per annum – the company will match them on a gross basis of one share for every two held after three years and another one for two originally held (i.e. a total of one for one) after five years.

For the award made in 1998, the earnings per share growth target of 16.6% for 1997 to 2000 was met and participants became entitled to the one-for-two match. On the third anniversary of the award, all participants elected to leave their shares in the plan so as to be eligible for the second one-for-two match, subject to the earnings per share target for 1997 to 2002 being met in 2003.

Executive directors’ interests and entitlements under this plan are shown in tables 3 and 4 below.

Equity-based incentives Eligible employees are covered by four different equity-based incentive plans:

• the incentive share plan of 1993;
• the reward plan of 1999;
• executive and special share options plans for employees not covered by the reward plan;
• the long-term incentive plan of 2001.

On an ongoing basis, the company currently only operates the latter plan. However, we summarise below the outstanding items under all four.

The incentive share plan This was introduced in 1993 to award executives of the Group based on the performance of the company over the medium to longer term as measured by total shareholder return relative to the average of the FTSE-100 total return index. In the light of external changes we substituted first the reward plan and now the long-term incentive plan for this. Dennis Stevenson’s is the only outstanding award under this plan covering the five-year performance period May 1997 to April 2002. The committee at the time decided it was appropriate that the Chairman’s long-term reward should be on a longer basis than that of the other senior executives whose awards were based on a three-year performance period.

Full details of any release of shares under this plan will be set out in the committee’s report for 2002 being the financial year covering the end of the performance period.

Dennis Stevenson’s entitlements under this plan are shown in tables 3 and 4.

The reward plan The Pearson Reward Plan had two elements: Pearson Premium Options (PPOs) linked to the rise in the Pearson share price over three to seven years and Pearson shares in the form of Pearson Equity Incentives (PEIs) linked to the three-year cumulative growth in Pearson’s free cash flow (being operating cash flow less tax liabilities on operating activities and interest paid). Two awards were made under this plan, one in 1999 and the other in 2000. Executive directors’ entitlements under this plan are shown in tables 3, 4 and 5.

For the different tranches of PPOs to become exercisable, the Pearson share price has to stay above certain thresholds for 20 consecutive days within specified periods as follows:

The share price targets for the three-year and five-year tranches of PPOs granted in 1999 were met in 2000. In addition, for options to be exercisable, the company’s adjusted earnings per share has to increase in real terms by at least 3% per annum over the three-year period prior to exercise.

In its report for 2000, the committee said that, in relation to the PEIs awarded in 1999, the exceptionally high free cash flow for 1998 arising from a cash conversation performance of 102% made a double digit increase target from the 1998 base unrealistic in the context of the plan. As a consequence, the committee re-calibrated the targets for the 1999 to 2001 performance period based on the free cash flow that would have been derived from a 95% cash conversion, which, in the committee’s view, is a good, but more normal, level of performance. On this basis, the threshold for pay out, at which 50% of the shares awarded became payable was a cumulative pre-internet free cash flow per share of 131.0p and the target for 100% pay out was 143.6p. Maximum pay out under the plan is 150% of shares awarded. Actual performance was 142.9p resulting in a pay out of 97.2% of shares awarded.

The PEIs awarded in 1999 vest on 8 June 2002. Following vesting, the shares remain subject to a two-year retention period and participants may call for their shares at any time until 8 December 2004. Shares may only be sold during the two-year retention period to satisfy any liability to tax or social security contributions that arises on calling for the shares. Any movement in shares for executive directors will be set out in the committee’s report for 2002.

For executive directors, table 4 indicates the number of shares out of the maximum number of shares that could have vested that have lapsed.

The vesting of PEIs awarded in 2000 is related to performance over the period 2000 to 2002. The committee will set out the targets used in its report for the final year of that period.

Executive directors and managers covered by the reward plan were not eligible for grants of conventional share options in any year in which they received an award under the reward plan.

Executives and special share options plans Options at market value at the date of grant were granted to eligible employees not covered by the reward plan.

Under the executive share option plan, awards were within individual and overall limits authorised by shareholders. The exercise of options granted since 1996 is subject to a real increase in the company’s adjusted earnings per share over a three-year period. For options granted in 1998, the target for 1997 to 2000 was growth in our adjusted earnings per share of 13.6% (for the options granted in March 1998) and 16.6% (for the options granted in September and December 1998). These targets were met and, as a consequence, these options became exercisable on 26 March 2001, 14 September 2001 and 2 December 2001 respectively.

In 2000, Pearson made one-off share option and restricted share awards under a special share programme that the board adopted and introduced on the recommendation of the committee to deal with competitive and employee retention issues in our internet and internet-related businesses at that time. The exercise of share options granted under this programme is not subject to performance conditions. The vesting of restricted shares is subject to a real increase in the company’s adjusted earnings per share of at least 3% per annum over the three-year period 1999 to 2002. No new shares will be issued to satisfy awards under this programme and executive directors were not eligible to participate in it.

The long-term incentive plan The plan consists of two parts:

• stock options;
• restricted stock.

The aim is to give the committee a range of tools with which to link corporate performance to management’s long-term reward in a flexible way. The principles underlying it are as follows:

• the vesting of restricted stock awards is normally dependent on the satisfaction of a stretching corporate performance target over a three-year period;
• the committee establishes guidelines that set out the maximum expected value of awards each year using an appropriate methodology for fixing the relative values of both option grants and restricted stock awards;
• the maximum expected value of awards for executive directors is broadly calculated by bringing expected total compensation to the upper quartile of market practice for a selected group of comparable companies in the US and the UK;
• no more than 10% of Pearson equity will be issued or be capable of being issued under all Pearson’s share plans in any ten-year period commencing in January 1997. Within this overall 10% limit no more than 1.5% of new-issue equity may be placed under option under the plan in any year;
• awards of restricted stock are satisfied using existing shares.
• The first round of awards in 2001 was as follows:
• the committee agreed the maximum 1.5% of new-issue equity for option grants under this plan (having satisfied itself that the company had achieved the growth in earnings per share required to allow it to release the options);
• the vesting of the restricted stock awards made in 2001 is related to performance over the period 2001 to 2003. The committee will set out the targets used in its report for the final year of that period;
• executive directors and senior executives received a blend of stock options and performance-related restricted stock. Using a simplified version of the ‘Black Scholes’ model, each option was valued at approximately 40% of the market value of the shares at the date of grant. Performance-related restricted stock awards were valued at 80% of the market value of the shares comprised in the award;
• in line with our policy, the expected values of the awards for executive directors were three times salary for Marjorie Scardino and twice times salary for John Makinson and David Bell. Details of these share option grants and restricted stock awards are set out in tables 3, 4 and 5.

Shareholding policy In line with its policy of encouraging widespread employee ownership, the committee has been keen to encourage executive directors and the chairman to build up a substantial shareholding for the company. In view of the volatility of the stock market, we do not think it is appropriate to specify a particular relationship of shareholding to salary. However, we intend from now to describe separately in this report both the numbers of shares that the executive directors and the chairman hold and the value expressed as a percentage of base salary.

The current value of holdings based on the middle market value of Pearson shares of £7.70 on 1 March 2002 (being the latest practicable date prior to the announcement of the results for 2001) against current base salary is as follows:

Service contracts All executive directors have agreements that can be terminated by the company on 12 months’ notice. In the case of early termination of their contract by the company without cause, these contracts provide for liquidated damages equivalent to 12 months’ base salary, benefits and a proportion of bonus. During the year no material changes were made to the service contracts of executive directors. Non-executive directors do not have service contracts.

Non-executive directors’ remuneration Fees for non-executive directors are determined by the full board with regard to market practice and within the restrictions contained in the articles of association. Fees are reviewed annually with the help of outside advice. Non-executive directors receive no other pay or benefits (other than reimbursement for expenses incurred in connection with their directorship of the company) and do not participate in the company’s equity-based incentive plans.

Since January 2000, non-executive directors have received an annual fee of £35,000 each. One overseas-based director is paid a supplement of £7,000 per annum. The non-executive directors who chair the personnel and audit committees each receive an additional fee of £5,000 per annum. £10,000 of the total fee, or all of the fee in the case of Rana Talwar, is payable in the form of Pearson shares which the non-executive directors have committed to retain for the period of their directorships.

Retirement benefits The highest paid director, Marjorie Scardino, has pension arrangements comprising defined benefit and defined contribution arrangements in the US. She participates in the funded, approved Pearson Inc. Pension Plan. This is a non-contributory final salary arrangement providing a lump sum convertible to a pension on retirement. The lump sum currently accrues at 6% of capped compensation. In 2001, the committee undertook a review of Marjorie Scardino’s overall remuneration. As a consequence of this review, the company’s contribution to the unfunded, unapproved defined contribution arrangement in which she participates was increased. The notional company contribution for 2001 was £431,250.

John Makinson and David Bell are members of the defined benefit section of the Pearson Group Pension Plan (the Plan), with a member contribution of 5% of pensionable salary.

It is anticipated that John Makinson will receive a pension of two-thirds of capped salary at normal retirement date (inclusive of benefits transferred from his previous pension plan). John Makinson is subject to the pensions earnings cap introduced by the Finance Act 1989. He participates in the company’s Funded Unapproved Retirement Benefits Scheme (FURBS) arrangements, under which a contribution equivalent to 31.1% of his annual salary was made by the company in 2001 to compensate him for pension benefits that cannot be provided from the Plan because of the pensions cap regulations.

David Bell is eligible for a pension from the Plan of two-thirds of his final base salary at normal retirement date due to his previous service with the Financial Times.

Both UK executive directors are also eligible for dependants’ pensions and a lump sum payment on death in service. Details of directors’ pension arrangements are set out in table 2 of this report.

Remuneration of the directors Excluding contributions to pension funds and related benefits set out in table 2, directors’ remuneration was as follows:

* ‘other’ excludes pension contributions.
† Includes amounts to former directors.

note Marjorie Scardino was the highest paid director in 2001. Her base salary increased by 10.5% from £475,000. Her total remuneration, including pension contributions, amounted to £1,129,584. For Marjorie Scardino, David Bell and John Makinson, ‘other’ emoluments include company car and health care benefits. Also included in ‘other’ emoluments for Marjorie Scardino is £35,770 in respect of housing costs. Marjorie Scardino, David Bell and John Makinson were entitled to bonuses of £157,500, £93,000 and £112,500 respectively. As reported earlier, they decided not to take their bonuses this year.

note 1 The increase in accrued pension during the year excludes any increase for inflation. Accrued pension is that which would be paid annually on retirement at 62, the normal retirement age under the Pearson pension plan in the UK, based on service to 31 December 2001. As members of the UK plan, David Bell and John Makinson have the option to pay Additional Voluntary Contributions (AVCs). They did not pay any AVCs in 2001.
note 2 The column headed ‘other pension and related benefits costs to the company over the period’ comprises payments to FURBS and pension and insurance supplements for UK benefits. For US benefits, this includes life assurance, Group term life cover, long-term disability insurance, company contributions to the Pearson Inc. 401(k) and excess savings and investment plans and notional contributions to Marjorie Scardino’s notional defined contribution plan.
note 3 Pension and related benefits costs for Marjorie Scardino include arrears of payments in respect of her long-term disability cover to January 1997. The annual cost in respect of 2001 was £20,026.

Further information relating to directors’ pensions:

Early retirement UK directors and other UK employees may retire before the normal retirement age of 62 and receive an immediate pension provided they have obtained company consent. In such cases, the pension entitlement from the UK plan will be scaled down to reflect the shorter service in accordance with normal actuarial practice. Early retirement reduction factors will also be applied to the accrued pension if retirement occurs before age 60. The earliest any director can retire and receive an immediate pension from the UK plan other than on ill-health grounds is age 50. Under the company’s FURBS arrangements, early retirement is possible with company consent from age 50 onwards. The benefit payable will be the amount of the member’s fund at the relevant date. In the US, Marjorie Scardino has a normal retirement age of 65 but may retire with company consent from age 55 with a reduced pension on a broadly equivalent actuarial basis.

Dependants’ pensions If a UK director dies while in employment before normal retirement age, a spouse’s pension will be payable from the UK plan, or in the absence of a spouse to a financial dependant nominated by the member. The amount of the pension will be one-third of the director’s annual base salary (capped in the case of John Makinson). If a former director dies after leaving service but before retirement, a pension of 50% of the director’s deferred pension will be payable to the spouse or nominated financial dependant. If John Makinson or David Bell dies in retirement, the pension payable to their spouse or nominated financial dependant will be 60% of the director’s pension. Children’s pensions may also be payable to dependent children. As a member of the company’s FURBS arrangements, John Makinson’s member’s fund would be paid to his dependants if he died before drawing it. Marjorie Scardino’s US plan provides a spouse’s pension on death in service from age 55 and death-in-retirement benefits broadly equivalent to 50% of the member’s pension on early retirement.

Pension increases John Makinson and David Bell are guaranteed post-retirement pension increases at the rate of 5% per annum or the Retail Price Index, if lower. The guaranteed increases relate to the non-Guaranteed Minimum Pension element of the pension. The plan has a recent history of providing discretionary pension increases at the full Retail Price Index rate. The US plans provide no guaranteed post-retirement pension increases for Marjorie Scardino.

† Amounts include shares acquired by individuals under the annual bonus share matching plan.
‡ Restricted shares comprise awards made under the incentive share, reward and long-term incentive plans. The number of shares shown represents the maximum number of shares, including accumulated share dividends on incentive share plan shares but not on reward or long-term incentive plan shares, which may vest, subject to the performance conditions being fulfilled.
†† These shares are held in trust and represent the maximum award required to provide the company’s matching contribution of shares in respect of that part of the bonus taken in shares by each director. The shares only vest if the performance and other conditions of the plan are met.
note On 2 January 2002, Terry Burns and Vernon Sankey each acquired 184 shares in the company. On that date, Reuben Mark and Rana Talwar acquired 239 shares and 761 shares respectively. The shares were acquired as part of their directors’ fees.
note Executive directors of the company, as possible beneficiaries, are also deemed to be interested in Pearson Employee Share Trustees Limited, the trustee of which held 244,639 Pearson ordinary shares of 25p each at 31 December 2001 and also at 4 March 2002.

Interests of directors in listed subsidiaries
At 31 December 2001 Marjorie Scardino, John Makinson and David Bell each held 1,000 shares in Recoletos Compañía Editorial, S.A. Dennis Stevenson held 8,660 shares.

* Restricted shares comprise awards made under the incentive share, reward and long-term incentive plans. The number of shares shown represents the maximum number of shares which may vest, subject to the performance conditions being fulfilled.
note Cash dividends may be paid on incentive share plan shares.

note The option prices and market prices have been rounded up to the nearest whole penny.
note Shares under option on 31 December 2001 are designated as: a executive or long-term incentive options; b Save for Shares options; c premium priced options; and * where the options are exercisable.
The register of directors’ interests (which is open to inspection during normal office hours) contains full details of directors’ shareholdings and options to subscribe for shares. The market price on 31 December 2001 was 791p per share and the range during the year was 1726p to 645p. Subject to any performance criteria being met, outstanding executive and premium priced options become exercisable on the third anniversary of the date of grant and lapse if they remain unexercised after the tenth. Save for shares options become exercisable on the third, fifth or seventh anniversary of the start of the contract and lapse if not exercised within six months after that anniversary. The long-term incentive options become exercisable on the first, second, third and fourth anniversary of date of grant and lapse if they remain unexercised after the tenth.