The current economic shut-down coupled with dramatic variability in the prices of listed equities means that executive long-term compensation plans are under-water. Given the extended time frame of poor corporate performance and resultant pressure on share prices, many executive share-based payment plans are unlikely to materialise. These share-based payments often make up a significant proportion of executives’ total pay packets and this leaves many wondering if they are being fairly compensated for the risk and workload they are shouldering.
“Many share-based payment schemes are no longer fit for purpose as they will not achieve the objectives for the organisation concerned,” says Guy Addison from advisory firm Addison Comline. He adds: “The combination of poor equity performance, cancelled dividends and lacklustre economic growth has proven a lethal concoction to these schemes – they are permanently impaired.”
Why companies are cancelling their share-based payment structures
In certain instances, companies have allowed executives to ‘gear’ (i.e. borrow) against these positions with financial institutions thereby increasing their expected gain from a relatively modest number of shares awarded. With significant obligations on the other side of their incentive structures, should these structures need to be unwound, then this results in downward pressure on share prices. Recent examples of this include Mediclinic and EOH where derivative positions were closed out when the collateral no longer covered the loans taken. We have also seen others like RCL and Brait cancelling their structures due to the input details at which such structures were set being different to the current factors in the economy.
Why should we care?
These structures are still driving the behaviour of the executive concerned. This may lead to executives taking inappropriate decisions in order to drive the share price up (or down) in order to take advantage of such movements. It is the unintended consequences of these structures that everyone should be aware of – especially company boards and those responsible for the remuneration policies of listed companies. Value destroyed at listed companies, means we all suffer, including ordinary citizens of our country that rely heavily on listed companies to pay taxes, provide services and employ people.
“Over the past two decades, government has enacted various new tax measures that have severely taxed executives,” says Addison. From Capital Gains Tax (CGT) in the early 2000’s to increasing the restrictions on share instruments which took place as recently as 2016. What this means is that executives rarely hold the shares in the companies they work for. They simply sell them, pay the tax and pocket the remaining cash to use elsewhere. Current structures do not support the overall objectives of aligning shareholders with management. Corporate governance bodies and stock exchanges are considering legislating minimum-shareholder-requirements (often called MSR’s) in an attempt to get Executives to actually hold onto the shares that they are awarded instead of just selling them as quickly as possible.
But, little is being done to make remuneration more efficient. Instead, ordinary shareholders are just paying more and more. In fact, due to the improbable input factors being used, government is not seeing the needed tax revenue from such structures and hence are likely to take a far more rigorous approach when such schemes vest.
The current system of remuneration is set-up in such a way that forces executives to worry about pushing the share price up in order to activate their Long-Term Incentives. But because of ‘poor’ returns earned, executives are demanding greater basic pay with no link to ordinary shareholders returns – contributing to less emphasis on long term value maximising efforts for shareholders in general. Ordinary shareholders are sacrificing more and more due to the inefficiency of the current Long-Term Incentive structures being implemented.
Addison goes on to say ‘because of the above, shareholders, management and boards are disillusioned with the time, effort and costs being incurred to reset structures that appear broken from the start. No one is happy with the situation – but they also don’t know what to do about it’.
What should be done with the broken structures
It is highly likely that Company Boards will take advice on their structures from the same consultants that recommended the implementation of such policies in the first place. More structures will be unwound / cancelled in the coming cycle or at the very least ‘re-set’, but at new strike values and input factors. Stakeholders including institutional shareholders regulators and shareholder activists are increasingly likely to take exception to this. They are starting to see this as changing the goal-posts without acknowledging the need to deliver value.
Addison proposes three changes that remuneration committees need to consider:
- Boards should go back to their advisors and ask them the difficult questions about why such structures need to be re-set.
- Participants of such structures should engage more actively with a broader set of stakeholders to ensure consistency and alignment of outcomes. This will become increasingly important as remuneration votes become binding.
- Listed companies should consider phasing out the use of ‘restricted’ structures in favour of unrestricted shares. Executives are expected to steward these businesses as responsible managers and hence they should be treated them the same way as regards their Long-Term Incentive plans.
Addison concludes: “2020 has given us an opportunity to correct many inappropriate corporate practices – not least of which are inappropriate incentive structures. This could be one of the best outcomes from the current Covid induced crisis.”