The current economic shut-down coupled with dramatic falls 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 of these share-based payment plans are unlikely to materialise. These share-based payments make up a significant proportion of executives’ total pay packets. And hence, we can expect more attention by market participants.
Guy Addison a corporate finance consultant discussed this issue with Marc Ashton to get to unpack some of issues. Guy maintains that many share-based payment schemes are no longer fit for purpose as they will not achieve the objectives for the organisation concerned. The combination of poor equity performance, high interest rates and lacklustre economic growth has proven a lethal concoction to these schemes – they are permanently impaired.
Why companies 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, we are seeing extra-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 so 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 the poorest citizens of our country that rely heavily on corporations 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. From CGT in the early 2000’s to increasing the restrictions on share instruments which took place as recently as 2016.
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 to current schemes.
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 – as a result of these ‘poor’ returns earned, executives are demanding greater basic pay. More guaranteed 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 being diluted to a greater and greater extent due to the inefficiency of the current Long-Term Incentive structures being implemented.
As a result of poor advice and a lack of understanding many disadvantageous structures are in place. Leading to disillusionment by management and wasted costs for companies and shareholders. There is turmoil at companies, within board rooms and across the remuneration landscape as no one is really happy – but they also don’t know what to really 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 (ie asset managers and life companies), 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.
Instead, we suggest that Boards should first and foremost go back to their advisors and ask them the difficult questions about why such structures do not work in our current economic environment. Secondly, Board Members should engage more actively with a broader set of stakeholders to ensure consistency and alignment of responses. So that they are able to adequately respond to the various stakeholders on why incentive plans are being changed. Thirdly, and most dramatically, listed companies should curtail the use of share-based payment structures in favour of unrestricted shares. Executives are expected to steward these businesses as responsible managers, we should treat them the same way as regards their Long-Term Incentive plans.
Background information on Guy Addison / AddisonComline
Guy Addison has worked with listed and private companies on share structures, strategy and governance challenges for over two decades.
Addison Comline is a professional services firm providing insight, advice and direction on corporate finance and law matters. We help clients achieve their business and financial goals, providing custom designed solutions, with an emphasis on high-impact, value-enhancing work that is clearly understood and supported by all stakeholders.
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