Long-Term Incentive (LTI) schemes are once again in the limelight as companies cancel their share-based payment plans.
- Why this matters
Astute investors will have noticed that RCL Foods has recently brought bought its own shares from management – essentially nullifying the incentive structure for such executives. Not only does this result in cash resources being used, but it also points to a broken remuneration plan and implementation for said company. In these turbulent times, it is likely that many more companies will realise that their current remuneration and incentive plans are no longer fit for purpose. This will result in a dramatic shift in executive remuneration strategies and structure as boards begin to grapple with the post-lockdown world. This means that shareholders will have another opportunity to influence currently unpopular remuneration plans.
2. What are share incentives?
The most popular Long-Term Incentive (LTI), until now, has been Share Appreciation Right (SAR) aka Bonus Shares aka Conditional Share Plans. These structures remunerate executives based on gains in the value of share price over a specified time frame. 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. Historically, share incentive arrangements have been the most important means of attracting and retaining management to the companies they work for. Ordinary shareholders in such companies hope that it also aligns managements interests with themselves. However, the combination of poor equity performance, high interest rates and lacklustre economic growth has proved a lethal concoction to these schemes.
More guaranteed pay with no link to ordinary shareholders returns
Management remuneration is increasingly being weighted towards ‘other’ elements at the expense of shareholder value. For example, Sasol has reduced the exposure of management remuneration to the economic performance of the company to a mere 25%, essentially admitting that the previous weighting “attached to core headline earnings is considered too high given that macroeconomic conditions have a major influence on this target” (Sasol Annual Report 2019, pg 25). As a result of these ‘poor’ returns earned, executives are demanding greater basic pay. Whilst the fiscus (SARS), enjoy a healthy 45cents in every Rand of this basic pay due to this being taxed at ones marginal tax rate, it is often ordinary shareholders who foot the bill as they watch their ordinary share value whittled away with little consequence for management. These actions are contributing to less emphasis on long term value maximising efforts for shareholders in general.
There is an increasing focus by executives on the use of derivative structures to leverage their current exposure to the share price of the company they serve. These schemes limit the downside risk to participants but place the company at risk – as the company often stands surety for any credit risk exposure. EOH, Brait and Tsogo Sun have all bailed out their executives when these schemes have not worked. These derivatives often exacerbate share price movements when there is a general sell-off in shares as experienced recently due to the Corona virus pandemic.
Out with the old…
Remuneration structures and policy today is largely a commoditized ‘cookie cutter’ approach where the same structures are used across industries and businesses with little thought given to the specific circumstances facing the organisation and its people. The result of this ‘fixed’ thinking is that such remuneration strategies are proving cumbersome and ineffective tools by which organisations can shape the performance of their management and employees. Hence, company boards are cancelling these structures, but with little guidance on what they are replacing them with.
What should be done?
It is clear to ‘activist’ shareholders that current long-term incentives no longer align management with the shareholders they serve. Many of these schemes are ‘underwater’, with management rightfully frustrated and demotivated by a ‘best-of-breed’ strategy that just hasn’t worked. As a result, company’ boards are going to have to return to the drawing board for some deep thinking (and action) on their current executive remuneration policy and implementation plans.
Key actions that boards and remuneration committees should be undertaking at this time should include:
- Lengthening what is considered “long term” from three years to at least five years.
- Enforcing minimum shareholding requirements for executives.
- Consideration of alternative methodologies that link management reward to long-term shareholder value creation.
The ability for an organisation and its stakeholders to understand and chart new ways of doing business in these times will reinforce the adage that learning coupled with action are the ultimate competitive advantage. The opportunity presented by the current market turmoil should be put to good use to correct what is clearly not working for shareholders.
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