Key Takeaways

• LTI plans with multiple performance measures can reduce the risk that nothing will vest.
• Of all LTI plans in ASX 100 companies that were tested in 2018-2025, 25% had a nil vesting outcome.
• Over 40% of LTI plans that relied on a single performance measure had a nil vesting outcome, reducing to 12% for plans with 3 or more measures.
• While having more performance measures also reduced the chance of 100% vesting, the average vesting outcome increased with the number of performance measures used. This suggests that the perceived value of the LTI for executives can be higher if multiple measures are used compared to plans that rely on a single performance measure.
• And boards may want to consider the risk of having executives focus on just one measure of performance to detriment of valid measures not incentivised.

Higher expected LTI vesting with more performance measures

Our analysis of LTI vesting outcomes in ASX 100 companies confirms that the risk of nil vesting reduces if multiple measures are used.

It also shows that expected vesting outcomes can increase with more performance measures:

Table 1: ASX 100 LTI vesting outcomes 2018-2025 by number of performance measures

 

While the average and median vesting outcome was ~50% for LTI plans with 1 or 2 performance measures, vesting outcomes increased to ~60% for plans with 3 or more measures.

LTI plans with 3 or more measures often included strategic or other non-financial measures with hurdles that may be less challenging to achieve than measures based on TSR or profit growth.

Volatility in vesting outcomes reduced as more measures were used.

The full distribution of vesting outcomes is illustrated below:

Figure 1: Distribution of ASX 100 LTI vesting outcomes 2018-2025 as % of maximum

Of all LTI plans tested in 2018-2025, 25% had a nil vesting outcome. For plans with a single measure, over 40% of LTI grants that were tested resulted in nil vesting. The prevalence of 0% vesting outcomes reduced with the number of measures used.

Even for plans with 2 measures, over a quarter of LTI grants that were tested resulted in no vesting for executives. This can be due to performance ranges being relatively narrow and the measures being correlated. For example, in LTI plans with 2 measures, the most common combination was relative TSR and EPS. As EPS targets will typically consider analyst consensus estimates at the time of grant, EPS outcomes that are below market expectations can be expected to have a negative impact on TSR performance as well, resulting in threshold requirements not being met for either measure.

LTI plans that included 3 or more performance measures had a significant reduction in 0% vesting outcomes and more outcomes in the upper half of the distribution, resulting in a higher average outcome.

While the chance of achieving 100% vesting also reduced as more measures were used, this is a trade-off many executives would probably be willing to accept if the average vesting outcome could be increased.

Lastly, boards need to consider the risk of having executives focus on a single LTI measure. It is unlikely that a single measure encompasses the many facets that contribute to sustainable value over time. A single or 2 measures may have unintended consequences as other important elements are neglected.

 

So what can boards consider?

Many prefer LTI plans that have multiple measures of performance as they better reflect a more fulsome and valid performance assessment, reduce risk of executives obsessing over a single aspect of performance and neglecting others, ensure more variability of pay, reduce risk of turnover as some aspect of the incentive on foot is likely to vest, and provides ample evidence of outperformance in the unusual instance that maximum vesting occurs.

Therefore, boards could consider:

• Introducing additional performance measures. Not only can this be expected to reduce the risk of nil vesting, average or expected vesting outcomes may also increase with more measures.
• Adopt measures that are less correlated than TSR and EPS growth. For example, capital efficiency measures such as ROIC can be less correlated with TSR, reducing the risk that nothing will vest if 2 measures are used.
• Adopt a wider range of performance requirements for each measure.

 

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