Institutional investors question the basis of LTI grants, and many boards are ill prepared to respond
30/06/2014
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A 10 June 2014 Credit Suisse analyst report has been avidly consumed by major institutional investors during the past few weeks. It reinforces the suspicions of many investors that some methods for determining the number of share rights etc. to grant to an executive for a specified annual long-term incentive (LTI) remuneration value result in much higher executive pay than has been disclosed. Credit Suisse illustrates this with a hypothetical example that indicates a maximum LTI value twice as high as that disclosed, and then backs this up with data from 70 of the ASX 100 companies.

Newsletter subscribers and those who read our web site news might recall an article alerting remuneration committees to matters they should question in regard to their company’s LTI grant practices. Our article goes a bit further than the Credit Suisse report in explaining the inconsistencies and inequities in LTI grant practices across and even within companies, and can be found HERE.

This issue has been festering for years. Guerdon Associates has been advising our clients on the issues and appropriate policies and disclosures for fair and transparent executive pay during this time.

About six years ago, on the institutional shareholder side, proxy adviser ISS, and then Ownership Matters, began to focus on the “discount” being factored into the equity value being used to determine LTI grants and the absence of adequate disclosure. With the resolution of other “egregious” executive remuneration issues since the two strikes law, we expect this may be coming to the fore again as a key engagement issue during this coming proxy season

Directors need to be aware and have a checklist to respond to heightened investor awareness.

Below are some suggestions.

1.    Are grants based on the maximum value an executive can earn? If so:

a.    Make sure the word “maximum” appears in the Notice of Meeting for the CEO grant and remuneration report

b.    Check that the equity value is based on fair value (i.e. the value of most share rights is the share price less present value of dividends during the vesting period). This is not necessarily the accounting value. It must not include any discount for the probability that some of the share rights etc. granted will not vest.

c.    Do the arithmetic, i.e. maximum LTI $ value = number granted*fair value

2.    Are grants based on the target value an executive can earn? If so:

a.    Make sure the word “target” appears in the Notice of Meeting for the CEO grant and remuneration report

b.    Is the equity value based on fair value discounted by the probability that some will not vest? This is not necessarily the accounting value. It must include a discount for the probability that some will not vest.

c.    Do the arithmetic, i.e. target LTI $ value = number granted*discounted fair value

d.    If target LTI is your company’s approach, have to hand the maximum value in any case, because you will be asked this at engagement meetings.

3.    Make sure all disclosures are transparent and consistent. That is, a discussion of the remuneration mix must either show all components at maximum or all at target, to be consistent with your grant method. Explicitly state the methodology for determining the number of equity vehicles to grant.

4.    If you discover that the grant basis is on share price only, and the arithmetic bears this out, it is not likely that this will raise any issues this season. Bear in mind, however, that unless the value of dividends is included in whatever vests to executives, the basis of the grant does not reflect the value actually granted. Address this by including the value of dividends in the equity vehicle next year. This would also provide better executive pay alignment with shareholder interests.

5.    If you discover that you grant on the basis of accounting value, and that this has resulted in an allocation based on a value discounted by the probability that some will not vest (i.e. where a market condition is used) and another allocation based on a value not discounted (i.e. where a non-market condition is used), then seriously consider changing policy. If caught with the consequences for this disclosure period, then transparently disclose that the basis of the grant is the accounting fair value. You will not be alone. But be prepared to respond to an investor query whether this is on the calendar for committee review.

© Guerdon Associates 2021
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