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Remuneration report

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Components of remuneration

The main remuneration components for the Chief Executive, Chief Financial Officer and Operating Board Directors are set out below:

i) Basic salary

Basic salary for each Executive Director is determined by the Committee, taking account of the Director’s performance, experience and responsibilities. The Committee also reviews Operating Board Directors’ salaries taking similar factors into account. The Committee considers salary levels in comparable companies by referring to the pay practices across the UK retail sector, in companies with an annual sales revenue over £5 billion and also in companies with a market capitalisation of between £3–£10 billion. This approach ensures that the best available benchmark for the Director’s specific position is obtained. The Committee also has regard to economic factors, remuneration trends and level of salary increases throughout the Company when determining Directors’ salaries.

With effect from 25 March 2007, Justin King’s base salary has been increased from £725,000 to £850,000 per annum. Since his appointment in March 2004, the Chief Executive has received pay increases in line with colleagues (3.7 per cent in 2005 and 3.6 per cent in 2006). However a recent salary review showed that his base pay had fallen significantly behind market median levels. The Remuneration Committee strongly believes that it is in the interests of shareholders to re-align his base salary with market competitive levels. Over a period of three years since his appointment, this will represent an increase of approximately 8.0 per cent per annum. Similarly, the base salary for Darren Shapland was increased from £450,000 to £500,000 per annum, reflecting a move to bring his base pay in line with market competitive levels in the sector.

For 2007/08, the base rates of our non-management store colleagues will increase by an average of 5.6 per cent, which will be paid in two instalments during the year.

ii) Incentive arrangements

In addition to basic salary, the Company currently operates incentive arrangements that comprise an annual bonus plan and long-term incentive plans. The Committee believes that incentive opportunities provided under these plans reflect an appropriate balance between personal and Group performance. As such, they align the rewards of Directors with the Company’s immediate business priorities and the longer term interests of shareholders.

The balance between the fixed (basic salary and pension) and variable (annual bonus and long-term incentive plan) elements of remuneration changes with performance, and the variable proportion of total remuneration increases significantly for increased levels of performance.

For median performance, with the introduction of the new deferred annual bonus plan and long-term incentive plan, it is anticipated that between 50 and 60 per cent of total remuneration for Executive Directors will be performance related.

Incentive arrangements for Executive Directors and Operating Board Directors for the 2006/07 financial year consisted of the Deferred Annual Bonus Plan and the new Long-Term Incentive Plan. Awards earned under each of the incentive plans are non-pensionable. The following section describes those plans in detail, together with the J Sainsbury plc Share Plan 2005 (known as the “Making Sainsbury’s Great Again Plan”), which is now closed and no further grants will be made under it.

Annual Bonus Plan

All bonus plans across the Company are aligned under a set of shared common principles. The 2006/07 Board and management plans retained the same key targets based on profit, sales and product availability, plus an element for personal performance. The Executive Directors, Operating Board Directors and all colleagues shared annual targets focused on sales and availability. Availability is measured across all stores on a regular basis by an independent third party, conducting random and unannounced store visits.

The Committee reviewed the Directors’ personal performance and achievement against the business related targets at the year-end. A payment will be made in respect of the sales, profit, availability and personal targets; the first two targets were achieved in full.

The 2006/07 bonus plan for store colleagues was based on the achievement of availability and customer service targets, measured in their individual stores, and a corporate sales target. As a result of store and corporate performance in 2006/07, around 118,000 colleagues will receive a bonus payment in respect of the 2006/07 financial year totalling around £56.0 million.

For the 2007/08 year, the maximum annual bonus opportunity will remain at 150 per cent of salary for the Chief Executive and 100 per cent for the Chief Financial Officer and Operating Board Directors. The Plan will retain the same elements as the 2006/07 Plan given that the key measures of profit, sales and availability remain vital to the continued delivery of the Company’s plans.

Deferred Annual Bonus Plan 2006

At last year’s AGM, shareholders approved the Deferred Annual Bonus Plan 2006, which applies to the Executive Directors, Operating Board Directors and Departmental Directors, comprising around 45 participants in total. The first deferral will take place in June 2007, in respect of the 2006/07 bonus awards.

The Committee believes that there should be a strong link between short-term and long-term performance both in terms of business targets and associated rewards. The Plan introduced a compulsory deferral of part of each participant’s earned bonus into Company shares for a three-year period. Subject to the Company’s TSR performance against an industry comparator group, there will be an opportunity for those shares to be matched by up to two times, dependent upon the extent to which the TSR performance measure has been met. The Plan is consistent with the Company’s remuneration policy, is designed to support the achievement of both short-term and long-term performance targets, introduces a further retention element and helps to promote share ownership among senior management.

Under the Plan, a percentage of participants’ earned gross annual bonuses is deferred into the Company’s shares for a period of three years. The compulsory deferral for the Chief Executive is 25 per cent of his gross bonus, with 20 per cent compulsory deferral for the Chief Financial Officer and Operating Board Directors and 10 per cent for Departmental Directors. In addition, participants may elect to defer a further proportion of their gross annual bonus, provided it does not exceed their compulsory deferral level. In respect of the 2006/07 bonus award, Justin King decided to defer the maximum level of 25 per cent of his bonus on a voluntary basis. Darren Shapland deferred 20 per cent of his bonus, the maximum allowed, on a voluntary basis.

To create a greater alignment between the Company’s and shareholders’ interests, the Plan measures the Company’s TSR performance over a threeyear period against a bespoke UK and European retail comparator group comprising: Tesco, Morrisons, Alliance Boots, DSG International, Kingfisher, Home Retail Group, Marks & Spencer, Next, Ahold, Carrefour, Casino, Delhaize and Metro.

Up to two matched shares may be awarded for each share deferred, depending on the extent to which the TSR measure is achieved. No shares are awarded for below median performance, and the full match will only apply where the Company achieves first place within the comparator group. At median position the match will be 0.5 shares for each deferred bonus share and the share match will be pro rated at every position between median and first place.

To the extent that the performance condition is met at the end of the three-year performance period, the matched shares will be added to the deferred bonus shares. The deferred bonus shares and half of the matched shares can be accessed immediately, while the remainder will be held over for a further year. Dividends or their equivalents will accrue on shares that vest.

For awards in 2007, the Remuneration Committee has determined that in order to measure performance on a fair and equitable basis, the opening TSR averaging period will be extended beyond the period of speculation and exceptional share price volatility following the CVC consortium’s conditional approach. The Committee decided it would be more appropriate to add six months to the three month averaging period immediately preceding the start of the 2007/08 financial year in order to smooth the distortion of the share price in the offer period. Our standard averaging period of three months will apply going forward assuming that no exceptional conditions apply at that time.

Long-Term Incentive Plan 2006

The top 1,000 managers in the Company participate in this Plan, from the Chief Executive to supermarket store managers, and share common performance measures.

Under the Plan a core award of shares in the Company is granted to all participants, calculated as a percentage of their salaries and scaled according to grade. In 2006/07, shares to the value of 45 per cent of salary were granted to Justin King, with Darren Shapland and the Operating Board Directors receiving grants equivalent to 35 per cent of their salaries. As set out below, dependent upon performance, core awards can grow by up to four times. No awards vest for performance below the threshold levels. For 2007, the Remuneration Committee has determined that, in light of the exceptional circumstances surrounding the Company in this year following the conditional approach by the CVC consortium, a core award of 62.5 per cent of salary will be made to Justin King, and core awards of 50 per cent of salary will be made to Darren Shapland and members of the Operating Board.

This is above the ‘normal’ award levels that will ordinarily be made under the Plan, but the Committee believes this will strongly align the interests of management with shareholders, and retain talent following a period of unusual activity for Sainsbury’s.

Awards vest based on the performance of two stretching co-dependent performance conditions: Return on Capital Employed (“ROCE”) and growth in cash flow per share, which will be measured over the three-year performance period. There is no retesting.

These measures are designed to build on the sales-led recovery plan and focus on creating further shareholder value. ROCE measures the efficiency with which new cash is invested and through which existing capital delivers profit, driving both cost savings and operational efficiencies. Cash flow per share captures the Company’s ability to generate cash for future investment or return to shareholders. In addition, the measures complement the sales, earnings and availability targets set under the annual bonus plan, and the TSR targets attached to the bonus deferral. The Plan measures are key indicators of business success and therefore create a further direct link between the interests of management and shareholders.

The ROCE and cash flow per share targets are challenging. For the 2006/07 Plan, maximum vesting requires ROCE of at least 14 per cent and annual compound growth in cash flow per share of 18 per cent or more. Following a review by the Committee, the same targets will apply for the 2007/08 grant. No awards will vest unless threshold levels of ROCE and growth in cash flow per share are achieved. The performance measures will be reviewed by the Committee each year, before a new grant is made, to ensure that they remain relevant and stretching.

ROCE and cash flow per share measures are calculated based on shareholders’ proportion of underlying operating profit for the business. The capital employed figure includes the net pension schemes deficit after deferred taxation but excludes the one-off impact of capital spend in the year the calculation is made. A normalised working capital figure is used in the calculation of cash flow and excludes the impact of cash contributions to the pension schemes. For awards made in 2006/07 the base ROCE and cash flow per share were 6.5 per cent and 38.3 pence respectively.

For the 2007/08 awards the base measures for ROCE and cash flow per share will be 8.6 per cent and 44.3 pence per share respectively.

Vesting is calculated by applying a performance multiplier to the core award on a sliding scale up to four times. The matrix is set out on within the Notes to the Financial statements. Straight-line vesting will apply if performance falls between two points.

Performance will be measured at the end of the three-year performance period. If the required level of performance has been reached, 50 per cent of the award will be released. Subject to participants remaining in employment for a further year, the balance will be released on the fourth anniversary of the date of grant. The Committee has discretion to make adjustments to the calculation of the performance measures (for instance for material acquisitions and disposals) to ensure it remains a true and fair reflection of performance. Dividends will accrue on the shares that vest in the form of additional shares.

J Sainsbury plc Share Plan 2005

The Business review in October 2004 concluded that a major sales-led recovery in profitability was needed. Accordingly, following extensive investor consultation, the J Sainsbury plc Share Plan 2005 (known as the “Making Sainsbury’s Great Again Plan”) was designed to reward strong growth in sales and profitability. It is a one-off, self funded incentive arrangement and was closed to new entrants on 25 March 2006.

Over 1,000 colleagues received conditional core awards under this Plan, from the Chief Executive through to supermarket store managers, focused on identical targets. The levels of core award were scaled according to seniority; the maximum being 100 per cent of salary for the Chief Executive. In addition, all Executive Directors and Operating Board Directors committed to making a personal investment of 50 per cent of salary in the Plan – accordingly Justin King and Darren Shapland acquired 118,754 shares and 70,224 shares respectively.

Performance is measured over a four-year period from the financial year ended 26 March 2005 until the year ending March 2009. Awards will vest if two stretching and co-dependent performance conditions are achieved: growth in sales and earnings per share (“EPS”).

The maximum award available under the Plan is targeted towards sales growth of £2.5 billion (using a base figure of £13,588 million), and compound annual growth in EPS of at least 21 per cent over a four-year period. There is an opportunity for partial vesting of up to half the award if accelerated performance targets have been met at the end of year three (the year ending March 2008). No awards will vest unless threshold levels of growth in both sales and EPS are achieved.

The EPS base year and targets were originally set under the Plan in accordance with UK GAAP. However, following the introduction of IFRS the Committee concluded that, in order to ensure that calculations were measured consistently and transparently and by reference to audited figures, the UK GAAP methodology should be replaced by IFRS. After considering various possible ways of restating the EPS base and target figures, the Committee agreed that the base year EPS should be updated to reflect IFRS. As a result EPS is now measured with reference to underlying basic EPS. This reduced EPS for the base year from 8.6 pence per share to 8.3 pence per share. The 3rd and 4th year targets will also be reduced by the same amount of 0.3 pence per share to maintain them at the same levels.

Vesting is calculated by applying a performance multiplier to the core award and personal investment; this is on a sliding scale from one times to five times and is plotted in a matrix format, as set out in Notes to the Financial statements. Dividends will accrue on any shares that vest and will be released to participants in the form of additional shares at the point of vesting.

In order to receive awards under the Plan, participants agreed to surrender options granted to them under the Company’s Executive Share Option Plan in 2002, 2003 and 2004. Justin King surrendered a total of 1,007,607 share options granted to him at exercise prices of 261.50 pence and 274.75 pence.

The Committee is mindful of the requirement to retain and incentivise our key leaders beyond the vesting dates in May 2008 and May 2009, and will continue to monitor the effectiveness of the current incentive framework, to this end.

iii) Other share plans

In order to encourage wider employee share ownership, the Company provides two all employee share plans for colleagues, namely the Savings Related Share Option Scheme (“SAYE”) and the All Employee Share Ownership Plan. Directors may participate in these plans in the same way as all other colleagues and Justin King is currently participating in both plans. Darren Shapland participates in the SAYE plan. As these are all employee plans there are no performance conditions.

The 2001 (five-year) SAYE plan reached maturity on 1 March 2007. Over 3,500 colleagues could use their savings and tax-free bonus to buy Sainsbury’s shares at the 302.0 pence option price. The 2003 (three-year) SAYE plan matured at the same time and a further 4,700 colleagues could use their savings and tax-free bonus to buy Sainsbury’s shares at the 241.0 pence option price. Nearly 7,000 of those colleagues with maturing Plans have so far exercised their options. Using the market price on the date of the first exercise, the value of all the shares subject to the maturity was in excess of £24.3 million.

We currently have over 23,610 colleagues participating in the SAYE plan with over 48,000 individual savings contracts.

iv) Pensions

The Company’s Defined Benefit Pension Plan was closed on 31 January 2002 and neither Justin King nor Darren Shapland participate in it. Justin King no longer participates in any Company pension plan and receives a cash supplement in respect of his taxable pensionable earnings.

Darren Shapland is a member of the Executive Stakeholder Pension Plan, a defined contribution arrangement which is open to all senior management. He contributes five per cent of his salary to the level of the earnings cap (2006: £108,600) whilst the Company contribution is 12.5 per cent of salary up to the cap. To the extent that his basic salary exceeds the earning cap, the Company pays him a cash supplement in excess of the cap.

During the year the Committee considered external benchmark data and guidance from Deloitte and concluded that the current pensions supplements were not set at market competitive rates. Accordingly, with effect from the start of 2007/08 the salary supplement in respect of Justin King was increased to 30 per cent of his full pensionable earnings, and, in respect of Darren Shapland and the participating Operating Board Directors, to 25 per cent of their over-cap pensionable earnings.

v) Benefits

Other benefits for Directors may include the provision of company car benefits and free private medical cover.