Annual report and accounts 2008

Report on directors’ remunerationSub‐section report on directors’ remuneration

Long-term incentives

At the Annual General Meeting in April 2006, shareholders approved the renewal of the long-term incentive plan first introduced in 2001.

Executive directors, senior executives and other managers can participate in this plan which can deliver restricted stock and/or stock options. Approximately 5% of the company’s employees currently hold awards under this plan.

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. It is not the committee’s intention to grant stock options in 2009.

Restricted stock granted to executive directors vests only when stretching corporate performance targets over a specified period have been met. Awards vest on a sliding scale based on performance over the period. There is no retesting.

Performance measures
The committee determines the performance measures and targets governing an award of restricted stock prior to grant.

The performance measures that have applied since 2006 and that will apply for 2009 and subsequent awards for the executive directors are focused on delivering and improving returns to shareholders. These are relative total shareholder return (TSR), return on invested capital (ROIC) and earnings per share (EPS) growth.

Total shareholder return is the return to shareholders from any growth in Pearson’s share price and reinvested dividends over the performance period. For long-term incentive awards, TSR is measured relative to the constituents of the FTSE World Media Index over a three-year period. Companies that drop out of the index are normally excluded i.e. only companies in the index for the entire period are counted.

Share price is averaged over 20 days at the start and end of the performance period, commencing on the date of Pearson’s results announcement in the year of grant and the year of vesting. Dividends are treated as reinvested on the ex-dividend date, in line with the Datastream methodology.

The vesting of shares based on relative total shareholder return is subject to the committee satisfying itself that the recorded total shareholder return is a genuine reflection of the underlying financial performance of the business.

The committee chose total shareholder return relative to the constituents of the FTSE World Media Index because, in line with many of our shareholders, it felt that part of executive directors’ rewards should be linked to performance relative to the company’s peers.

Return on invested capital is adjusted operating profit less cash tax expressed as a percentage of gross invested capital (net operating assets plus gross goodwill).

We chose return on invested capital because, over the past few years, the transformation of Pearson has significantly increased the capital invested in the business (mostly in the form of goodwill associated with acquisitions) and required substantial cash investment to integrate those acquisitions.

Earnings per share is calculated by dividing the profit attributable to equity shareholders of the company by the weighted average number of ordinary shares in issue during the year, excluding any ordinary shares purchased by the company and held as treasury shares (note 8 of the financial statements).

For 2008 and subsequent awards, earnings per share growth is calculated using the point-to-point method. This method compares the adjusted earnings per share in the company’s accounts for the financial year ended prior to the grant date with the adjusted earnings per share for the financial year ending three years later and calculates the implicit compound annual growth rate over the period.

We chose earnings per share growth because strong bottom-line growth is imperative if we are to improve our total shareholder return and our return on invested capital.

Pearson’s reported financial results for the relevant periods are used to measure performance. The committee has discretion to make adjustments taking into account exceptional factors that distort underlying business performance. In exercising such discretion, the committee is guided by the principle of aligning shareholder and management interests.

Restricted stock may be granted without performance conditions to satisfy recruitment and retention objectives. Restricted stock awards that are not subject to performance conditions will not be granted to any of the current executive directors.

Performance targets
The committee will set stretching targets for the 2009 awards that are consistent with the company’s strategic objectives over the period to 2011. It is the committee’s intention that these targets will be no less demanding than the targets for the 2008 awards. Full details of the targets and individual awards will be set out in the report on directors’ remuneration for 2009.

Value of awards
The committee’s independent advisers verify each year the expected value of awards i.e. their net present value after taking into account the vesting schedule, risk of forfeiture and the probability that any performance targets will be met.

The level of individual awards takes into account three factors: their expected values; the assessments by the committee’s independent advisers of market practice for comparable companies and of directors’ total remuneration relative to the market and the face value of individual awards and their potential value should the performance targets be met in full.

Dividends
Where shares vest, participants receive additional shares representing the gross value of dividends that would have been paid on these shares during the performance period and reinvested. The expected value of awards made on this basis takes this into account.

Retention period
Pearson wishes to encourage executives and managers to build up a long-term holding of shares so as to demonstrate their commitment to the company.

To achieve this, for awards of restricted stock that are subject to performance conditions over a three-year period, 75% of the award vests at the end of the threeyear period. The remaining 25% of the award only vests if the participant retains the after-tax number of shares that vest at year three for a further two years.

Outstanding awards
Details of awards made, outstanding, vested and held or released under the long-term incentive plan are as follows (subject to audit):

Date of award	Share price on date of award	Vesting date	Performance measures (award split equally across three measures)	Performance period	Payout at threshold	Payout at maximum	Actual performance	% of award vested	Status of award
04/03/08	649.5p	04/03/11	Relative TSR	2008 to 2011	30% at median	100% at upper quartile	—	—	Outstanding
			ROIC	2010	25% for ROIC of 8.5%	100% for ROIC of 10.5%	—	—	Outstanding
			EPS growth	2010 compared to 2007	30% for EPS growth of 6.0%	100% for EPS growth of 12.0%	—	—	Outstanding
30/07/07	778.0p	30/07/10	Relative TSR	2007 to 2010	30% at median	100% at upper quartile	—	—	Outstanding
			ROIC	2009	25% for ROIC of 8.5%	100% for ROIC of 10.5%	—	—	Outstanding
			EPS growth	2007 to 2009 compared to 2006	30% for EPS growth of 6.0%	100% for EPS growth of 12.0%	—	—	Outstanding
13/10/06	767.5p	13/10/09	Relative TSR	2006 to 2009	30% at median	100% at upper quartile	—	—	Remain held because the performance period ends after the date of this report
			ROIC	2008	25% for ROIC of 8.0%	100% for ROIC of 10.0%	9.2%	50% (see note)	Vested and remain held pending release
			EPS growth	2006 to 2008 compared to 2005	30% for EPS growth of 5.0%	100% for EPS growth of 12.0%	18.3%	100%	Vested and remain held pending release
23/09/05	655.0p	23/09/08	Relative TSR	2005 to 2008	40% at median	100% at upper quartile	76th percentile (26 out of 103 companies)	100%	86.7% of shares vested. Three-quarters released on 23 September 2008. If after tax number of shares are retained for a further two years, the remaining quarter will be released on 23 September 2010
			ROIC	2007	25% for ROIC of 7.5%	100% for ROIC of 9.0%	8.2%	60%
			EPS and sales growth	2005 to 2007 compared to 2004	30% for real growth in both sales and EPS	100% for 10% growth in either sales or EPS	EPS growth 20.4% Sales growth 5.0%	100%

Note In relation to the award made on 13 October 2006, the Committee noted the change in the calculation of return in invested capital and the resulting figure of 9.2% for 2008. The Committee agreed with the rationale for the change but considered that, given that the new basis of calculation differed from that used at the time the award was made, it would not be appropriate simply to use this basis for the purposes of determining payout on this element. The payout of 50% of shares originally awarded reflects the Committee’s judgement on this point.

All of the executive directors hold awards under the longterm incentive plan. Details are set out in table 4 and itemised as b or b*.