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Incentivising your people
Listed company long-term executive share incentive plans – Incentivising your people
Incentivising your people
This brochure is part of the Norton Rose Fulbright LLP ‘Incentivising
your people’ series which covers a range of equity and cash-based
employee incentive schemes. For more information on other arrangements which may be appropriate for your business please contact firstname.lastname@example.org Introduction We summarise below the main structures typically employed by companies listed on the London Stock Exchange Main Market for the purpose of delivering share incentives for
executives and, in particular, outline:
• the different types of share plan available
• the principal terms and features common to listed company share plans
• institutional investor guidelines, investor expectations and market practice.
Our intention is to provide a high level overview as a starting point to assist you in adopting a share plan portfolio which addresses your recruitment, retention and incentive objectives.
Which type of share plan should you adopt?
Two principal choices There are many different names given to share incentive arrangements: ‘option schemes’, ‘restricted stock’, ‘restricted stock units’, ‘long-term incentive plans’, ‘deferred share bonus plans’, ‘nil-cost options’ etc. However, the principal choice is between a Share Option (an
Option) and a Performance Share Award (a Performance Share Award):
Share Option An Option is a right to acquire shares in the future at a fixed price, usually equal to the quoted market price when the Option is granted.
Performance Share Award A Performance Share Award provides for free shares subject to performance conditions.
A Performance Share Award will take the form of either a ‘nil-cost’ option or a conditional award of shares which vests automatically.
02 Norton Rose Fulbright – May 2014 Listed company long-term executive share incentive plans – Incentivising your people What are the principal differences between an Option and a Performance Share Award?
Over the last few years, listed companies have tended to provide directors’ share incentives through Performance Share Awards rather than Options.
Many listed companies choose to grant Performance Share Awards subject to performance conditions to executive directors and Options subject only to service conditions to less senior executives.
In any event, we recommend that prior to listing a company adopts a share plan which allows for both Options and Performance Share Awards so that the remuneration strategy may be operated flexibly.
The main differences between Options and Performance Share Awards and the principal reasons why companies have favoured Performance Share Awards are set out below.
Incentive value An Option which is ‘underwater’ (i.e. the current share price is lower than the exercise price) holds little retention value and may even be disincentivising for the optionholder, particularly if, despite the share price, other performance criteria have nevertheless been met. Since Performance Share Awards are over free shares they will always hold some retention value regardless of share price movement.
Shareholder alignment Some investors feel that the exercise price of an Option can overly focus the executive on achieving short term share price movements as opposed to focusing on long-term growth.
On the other hand, it is argued that, since the value of a Performance Share Award relates directly to share price at any point in time, Performance Share Awards provide a better incentive to the executive to increase long-term share value.
In addition, delivering shares through Performance Share Awards encourages longer-term share ownership, whereas executives will generally sell all their Option shares immediately following exercise in order to fund both their exercise price and tax charges.
Dilution Options are very wasteful of shares and applicable dilution limits imposed by investors come under pressure more quickly if a company is delivering share benefits through Options.
Since Performance Share Awards provide free shares, the same net benefit can be delivered to the executive using fewer shares than with an Option and Performance Share Awards are therefore a more efficient form of incentive in terms of overall share numbers and dilution.
Accounting charges Accounting charges under International Financial Reporting Standard (IFRS) 2 Share-Based Payments can also reduce the relative attractiveness of Options compared to Performance Share Awards. In certain circumstances, a lower accounting charge can be achieved for the same benefit delivered to the executive by structuring the benefit through a Performance Share Award rather than through Options.
The Association of British Insurers (the ABI) publish guidelines on best practice for listed company share incentives (known as the ABI Principles) and these should, if possible, be followed. You can view the guidelines at http://www.abi.org.uk.
Investors expect share plans to specify individual annual maximum grant limits based on salary multiples. Broadly speaking, market practice is currently to apply a maximum limit of between 1-2 times an individual’s salary for annual Performance Share Awards and 2-3 times salary for annual Options (the value of the shares being calculated at the date of grant of the award). It is normally acceptable to exceed the grant limit in ‘exceptional circumstances’ such as an executive’s recruitment.
Typically performance is measured over a three year period, which means that an annual grant policy results in annual vesting or exercise opportunities. This phased annual grant approach will maximise the retention value of your share plan.
Performance conditions The remuneration committee will need to consider performance conditions and investors will pay close attention to conditions disclosed in the prospectus and in annual remuneration reports. The rules of the plan will provide your committee with wide discretion to adopt different performance conditions appropriate to the company’s long-term business strategy and there is no requirement for shareholders to approve these conditions.
Details of the performance conditions for the initial awards granted on listing or within the first year should be disclosed in the IPO prospectus and thereafter performance conditions applicable to directors’ awards must be set out in the company’s annual remuneration report.
Market practice in your sector is a key indicator of the conditions which are likely to be
acceptable to investors. However, by way of general guidance on overall market practice:
• Investors will expect more demanding performance conditions to apply to Performance Share Awards because these comprise free shares.
• It may be acceptable to grant market value Options to more junior management without performance conditions and only subject to continuing service.
• Investors will always expect performance conditions to apply to directors’ awards and conditions should normally relate to overall company performance such as growth in
income and/or share value. For example:
— the company’s growth in earnings per share (EPS) over three years must exceed inflation by a target percentage (usually not less than nine per cent) and/or — the company’s growth in total shareholder return (TSR) is compared to TSR growth against an index or group of comparator companies with upper quartile performance triggering full vesting.
• It is typical for companies to adopt ‘bi-furcated’ conditions, for example with 50 per cent of the shares subject to an award dependent on a TSR condition and 50 per cent dependent on an EPS condition with a range of targets set within each condition.
Whilst EPS and TSR are conventional conditions they may not provide relevant measures for all companies. Deciding on performance conditions can be the most difficult element of the share plan design and, if the appropriate conditions are not obvious, you should seek specific advice from a remuneration consultant.
It is common for the position to be varied for ‘good leavers’ who generally include executives whose employment is terminated involuntarily on account of death, injury, disability, redundancy or retirement. It is also typical to include a discretion to treat an executive as a good leaver in other circumstances the company deems appropriate.
The ABI recommend that good leaver awards vest on a pro-rated basis (i.e. taking into account the period the executive has served as a proportion of the award’s normal vesting period) and subject to any performance conditions. However, some companies simply reduce the award based on the foreshortened time period and waive the performance condition.
The terms of the plan will also provide for the possibility of a ‘roll-over’ of awards into shares of the acquiring company, which may be appropriate for executive retention.
The Listing Rules provide that, subject to limited exceptions, share plans must be approved by shareholders. However, this does not apply to any plans adopted prior to listing and fully disclosed in the Admission Prospectus and it is usual therefore for any company making an initial public offer to adopt all its share plans immediately prior to listing. In addition to Listing Rule requirements, UK incorporated companies trading on the Main List are now required to seek shareholder approval for their remuneration strategy (including the principal terms of their long-term share incentive arrangements) every three years or earlier if there is a material change in strategy.
06 Norton Rose Fulbright – May 2014 Listed company long-term executive share incentive plans – Incentivising your people The UK Corporate Governance Code requires that the overall remuneration strategy together with the arrangements for individual executive directors must be approved by its remuneration committee, comprising independent non-executive directors and appointed as part of the IPO process.
It is typical for remuneration committees to seek the advice of an independent remuneration consultant who, in addition to benchmarking services, will also be able to advise on detailed aspects of the share plans, including appropriate grant levels and performance conditions.
Norton Rose Fulbright has good relationships with a number of independent consultants and we are happy to recommend specialist advisers in this field if required.
Norton Rose Fulbright employee benefits and executive compensation team The Norton Rose Fulbright employee benefits and executive compensation team advises on all types of employee share schemes and cash bonus arrangements for listed and private companies operating in the UK and overseas. We are a dedicated incentives team providing wide-ranging advice on tax planning, company and employment law, corporate governance and best practice.
We believe in building long-term relationships with our clients and their management teams with many of whom we have worked from their initial start-up through MBOs, sales and IPOs. We have particular knowledge in designing and implementing tax-efficient incentive structures suitable for private and small listed companies anticipating strong growth up to and beyond anticipated exit events.
If you would like further information please contact:
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