NED shareholdings and diversity requirements run counter to each other. Now there may be a partial solution.
30/11/2015
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Board remuneration has remained relatively stable since the GFC. Increases have remained regular and modest. Companies have been making smaller and more frequent adjustments rather than the significant and infrequent adjustments prior to the GFC. Likewise, requests to shareholders for an increase in the director fee pool have been more frequent and more modest, heeding 5 years of proxy adviser requirements that these replace larger and less frequent requests.

What has changed in the past 2 years, and a trend likely to accelerate, are policies that recommend non-executive directors to hold equity. This is in direct response to proxy adviser reports measuring and commenting on the extent of NED shareholdings. More recently they have incorporated a requirement to disclose NED shareholding polices into their guidelines. This has been driven, to an extent, by feedback from investor clients that they would like to see more NEDs holding more shares.

The great majority of companies with NED shareholding polices have expressed these as “guidelines”. This is softer than accompanying polices for executives, which are usually expressed as “requirements”.

NED shareholding guidelines usually indicate that NEDs are expected to acquire shareholdings equal to a defined multiple of board fees over 3 or 5 years. Some go further, and dictate that NEDs utilise a defined proportion of the after tax cash fees to acquire holdings until the guideline is met.

Meanwhile, tax changes on 1 July mean that it is possible for NEDs to acquire equity in lieu of cash fees. Further, these can be configured in a way that does not compromise governance standards. That is, this equity can be acquired instead of cash fees while deferring tax without a forfeiture condition based on service or performance. So, in effect, holding guidelines could be met with before tax income.

While investor and proxy adviser preferences for NEDs to have larger shareholdings in the companies they oversee aligns the interests of NEDs and shareholders, it runs counter to institutional investor preferences for more board diversity. The pool of women qualified to be NEDs tend to be younger, with most experiencing career gaps for family reasons. Unlike the older, white male NEDs, many women do not have the same level of accumulated wealth. Giving up high paying full time jobs to be a NED, despite its attractiveness in terms of time commitments, does not pay the bills quite as well. Cash is still important. So being forced by a guideline to put some aside to accumulate equity does not do anything to attract these women to join boards.

Hence, NED shareholding objectives run counter to diversity objectives, despite both being desirable.

Therefore pre-tax equity in lieu of cash fees may be an effective method to ensure holding guidelines are met tax effectively, and a more acceptable method to younger, less wealthy NEDs needed for their diverse skills, experiences, and knowledge.

While this method of paying NEDs was a significant trend prior to the 2009 tax changes that stopped it in its tracks, there is no sign yet that this year’s “back to the future” tax changes have reignited the trend. But the logic for providing NEDs with pre-tax equity is even more compelling now than before 2009.

© Guerdon Associates 2021
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