Stephen Hester, chief executive of Royal Bank of Scotland, has agreed to a modest concession to his potential £9.7 million pay package after it provoked outrage last week.

Mr Hester has agreed to defer by two years cashing in incentive shares that could be worth £3.4 million in an attempt to defuse concern that his package was too focused on short-term performance. Free shares under the bank’s medium-term bonus scheme would vest in June 2012, it was announced last week, but Mr Hester has agreed to hold them for at least a further two years under a deal with institutional shareholders.

Some institutions were concerned that Mr Hester was being given an incentive to push the share price up in a way that could prove unsustainable.

Peter Montagnon, director of investment affairs at the Association of British Insurers, said: “This is a significant and welcome development. We want the value that Mr Hester creates to be sustainable and enduring. We believe this is very helpful and puts the focus on the longer term.” It was also in line with the philosophy of the new code on bankers’ pay laid out by the Financial Services Authority, he said.

The concession means that a substantial part of Mr Hester’s potential rewards will not be accessible for five years, a limit previously uncommon in the City, where until recently most bonuses were paid annually and in cash. However, the concession applies only to the medium-term performance plan and not a separate executive bonus scheme, which remains unchanged. Both schemes are subject to other performance criteria. To hit £9.7 million, the RBS share price would have to double to 70p. A smaller rise would lead to smaller rewards, a larger rise to larger ones.

RBS, which is 70 per cent-owned by the Government, sparked controversy when it announced the package. George Osborne, the Shadow Chancellor, called it “a one-way bet which smells of the old-style City”. Unite, the union, was “appalled”.

This week Lord Myners, the City Minister, said that rewards based on share prices encouraged directors to take excessive risk. However, a recovery in many markets has led to expectations that substantial bonuses are likely to be paid this year.

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