Executive share plans typically require staff to meet top performance criteria, says Laverne Hadaway
The shape of the schemes on offer today stems directly from the shareholder protests of the early 1990s against chief executives receiving lucrative share options, apparently for doing very little. Share schemes for executives are now typically characterised by tough performance conditions and a time period during which share options must be held.
Phil Ainsley, senior manager of employee benefits at Equiniti, formerly Lloyds TSB Registrars, says: “The UK has led the way in imposing performance criteria on executives’ share schemes.”
Shareholder remuneration committees now exercise strict control over how such awards are allocated.
Broadly speaking, there are three main types of executive share schemes: deferred share bonus plans, option schemes and long-term incentive plans (L-tips).
A deferred share bonus plan allows executives to earn a bonus based on performance over a single financial year. However, all, or part, of this is deferred and invested in the company’s shares. If the executive leaves before the end of the deferred period, they forfeit the bonus.
Under an option plan arrangement, executives are given an option to buy the company’s shares at a set price. Typically, these can be exercised between three and ten years after they have been granted and are usually, but not always, subject to specific performance criteria.
Under an L-tip, meanwhile, executives are allocated an award of shares on the condition that they perform satisfactorily over a set period. L-tips can take the form of performance or matching share plans. The former reward executives according to their performance often over a three-year period. Under a matching plan, executives invest their own funds in the company’s shares and receive free shares based on long-term performance criteria.
Employers can choose to measure executive and directors’ performance in a number of ways. They may wish to set criteria which focuses on raising the earnings per share of the company to a certain level or increasing the total shareholder return, for example. The danger is that in a volatile market, where options are geared to the organisation’s share price, any reward that executives receive is more to do with stock market gains than their own performance.
However, performance criteria may be more sophisticated and involve benchmarking the company’s performance against that of its competitors. The share awards may also reflect the degree to which the performance target has been reached. Where their performance is below median, they may get nothing at all. Rob Burdett, a partner at New Bridge Street Consultants, says: “It’s important to align executives’ interests with those of the shareholders. If the shareholder does well, so does the executive.”
But Ainsley admits that employers and shareholder remuneration committees have their work cut out. “Trying to establish a real element of risk is a key thing and to ensure that the conditions are challenging. It all depends on the type of business as to the kind of conditions you can set,” he explains.
Jonathan Watts-Lay, a director of JPMorgan Invest, says employers must watch that the performance criteria are relevant to individuals. “A chief executive may think it’s reasonable to set the raising of the price earnings ratio as a target, but a middle manager may question how [they can] influence it.”
Potential rewards also need to be motivating in relation to an executive’s salary. As such schemes are subject to tax, they must be suitably generous in order to be seen as sufficiently motivational.
Executive share schemes can also be used to recruit and retain this level of employee. They may also be dangled in front of a potential new recruit as a means of welcome or as a golden hello.
According to the 2007 FTSE 100 directors’ remuneration survey published last month by New Bridge Street Consultants, there has been a trend to move away from share option plans for executives and towards L-tips. This is partly because of tougher performance targets from shareholders, although it is mostly in response to a change in accounting rules in 2004, which specified schemes must be charged to a company’s income statement, making them less tax efficient.
Also, where there is likely to be high share price growth, options may be more expensive and use a higher number of shares to deliver the same reward.