Speaker 1: Welcome to you, our listener, and thank you for joining the Guerdon Associates podcast.
Speaker 2: Yeah, thanks for listening.
Speaker 1: This deep dive covers recent findings on executive incentive vesting outcomes and the structuring of performance targets. We explore the differences between face value and fair value equity grants alongside the utilisation of Monte Carlo simulations. Finally, we review the prevalence of dividend inclusions in executive incentives based on Guerdon Associates’ original research.
Speaker 2: It is great to be here. Setting executive remuneration policies involves a lot of moving parts and breaking down the mechanics behind these plans is essential for understanding how they operate in practise.
Speaker 1: So let us unpack this from the foundation up. Before we get into how equity plans are valued, we need to establish the facts regarding what actually vests in these executive incentive plans.
Speaker 2: Yeah.
Speaker 1: We consult Guerdon Associates’ articles published in May 2025 for this context. These articles record and analyse ASX listed company’s short-term incentive or STI and long-term incentive or LTI award outcomes.
Speaker 2: Yeah. That is the right place to start. The analysis in Guerdon Associates’ original research is based on incentive outcomes as a percentage of maximum opportunity.
Speaker 1: Right, the maximum opportunity.
Speaker 2: Yes, to give you some context on the mechanism here, well, Australian, UK and European investors and proxy advisors tend to focus on the maximum and the proportion paid of the maximum.
Speaker 1: Got it. So, Guerdon Associates’ original research records, the median ASX 100 CEO STI outcomes over a five-year period. In financial year 2020, the median STI outcome was 39%. And that outcome changed to 76% in financial year 2021.
Speaker 2: Yes.
Speaker 1: In financial year 2022, it was recorded at 71%.
Speaker 2: Okay.
Speaker 1: Then financial year 2023 was 64% and financial year 2024 was 62%.
Speaker 2: Yeah, and Guerdon Associates’ articles also record the median LTI vesting outcomes across that identical five-year span.
Speaker 1: Oh, let us hear those.
Speaker 2: So financial year 2020 was 48%.
Speaker 1: Right.
Speaker 2: Financial year 2021 was 43%. Financial year 2022 was 51%. Financial Year 2023 was 63%, and financial year 2024 was 53%.
Speaker 1: So taking those figures together across all five years. Well, the five-year average for STI was 60% and the five-year average for LTI was 51%.
Speaker 2: Yes. Historically, STI has higher vesting outcomes than LTI during the year, but it is also helpful to look beyond just the medians.
Speaker 1: Right. Guerdon Associates’ original research provides percentiles as well.
Speaker 2: It does. It gives us a picture of the range of outcomes for the LTI outcomes. The 25th percentile was 0% in financial year 2020. It remained at 0% in financial year 2021. Then the 25th percentile changed to 25% in financial year 2022. It recorded at 34% in financial year 2023 and changed to 1% in financial year 2024.
Speaker 1: And looking at the upper end of the scale, the 75th percentile for LTI was 86% in financial year 2020.
Speaker 2: Yes.
Speaker 1: It was 90% in financial year 2021 and 94% in financial year 2022. Right. The 98% in financial year 2023 and 95% in financial year 2024.
Speaker 2: Yeah. So LTI tranches, lapsing in full was a more common occurrence in financial year 2020 and financial year 2021. Guerdon Associates’ articles attribute this to the impacts of COVID as the affected years formed part of the performance periods.
Speaker 1: Got it. And the median STI outcome was lowest in financial year 2020 and highest in financial year 2021.
Speaker 2: Yes. Gordon Associates’ original research also attributes this to COVID impacts and the subsequent economic stimulus.
Speaker 1: Well, the research also considers outcomes by sector.
Speaker 2: It does. Yes.
Speaker 1: Guerdon Associates’ articles track median outcomes across materials, financials, healthcare, consumer discretionary, real estate, energy, communication services industrials, consumer staples, information technology and utilities.
Speaker 2: That is a lot of sectors.
Speaker 1: It is. I have a specific question about the sector level numbers recorded in Guerdon Associates’ original research. Could you list the facts for the information technology and healthcare sectors?
Speaker 2: I can. So, in the information technology sector, the median STI recorded above 70% in all years except 2020. In the healthcare sector the LTI recorded at 97% in financial year 2021 and changed to 25% in financial year 2024.
Speaker 1: Okay. For those of you listening who are involved in governance, the board director takeaway here is that the historical vesting percentages provide baseline context when reviewing a company’s own incentive outcomes across STI and LTI structures.
Speaker 2: Yes. Setting a baseline is step one, but external macroeconomic factors complicate the setting of future performance targets.
Speaker 1: Let us explore that complication. We look at Guerdon Associates’ articles published in May 2022 for this context.
Speaker 2: Right.
Speaker 1: The Reserve Bank of Australia’s decision on May 3rd of that year to increase the cash target rate for the first time in over a decade came after annual CPI recorded at 5.1% in March with underlying inflation at 3.7%.
Speaker 2: The RBA expectation detailed in the articles indicated underlying inflation to decline to the top of the target ban of 2-3% not until 2024.
Speaker 1: So operating in high inflation presents a challenge for boards setting targets for management incentive plans. To understand the mechanics of this challenge, well, we should clarify how these targets are built. Vesting scales utilise threshold, target and stretch limits. How do Guerdon Associates’ articles define these specific components?
Speaker 2: Okay, so threshold is the lower limit of acceptable performance. The mechanism here ensures no incentive is awarded below this level. Target represents the expectation of robust outcomes. The incentive awarded at this level of performance is communicated as the expected payment.
Speaker 1: Or the average outcome from the incentive plan over time.
Speaker 2: Yes, exactly. And stretch is the delivery of exceptional outcomes above expectations. The maximum incentive opportunity is awarded at this level of performance.
Speaker 1: Got it. So financial measures such as earnings per share or EPS growth are challenging to calibrate for LTIs in some industries,
Speaker 2: They are.
Speaker 1: Removing the impact from inflation on actual earnings growth for performance measurement purposes means management is not punished for factors outside their control.
Speaker 2: But Guerdon Associates’ original research notes, this is difficult to do in practise.
Speaker 1: Why is that?
Speaker 2: Well, each line item in the income statement requires deflating to arrive at the real earnings growth number.
Speaker 1: I see.
Speaker 2: Furthermore, companies with overseas sales face different inflation rates across different currencies over the performance period.
Speaker 1: So do Guerdon Associates’ articles detail specific alternative measures to replace EPS growth in these high inflation environments?
Speaker 2: Yes. There are four structural alternatives for target setting. The first is to increase the vesting range between threshold and stretch. With expected volatility and earnings. Extending the range ensures incentive outcomes accommodate uncertainty within the performance period.
Speaker 1: And the second structural alternative.
Speaker 2: It is to replace growth measures with a measure of capital efficiency. Return on invested capital, known as ROIC or return on equity, known as ROE, are calculated as an average annual return achieved over the LTI performance period.
Speaker 1: Right.
Speaker 2: Guerdon Associates’ original research indicates outcomes here are less volatile than growth measures such as EPS.
Speaker 1: I mean, that makes sense. What is the third structural alternative?
Speaker 2: The third structural alternative is to replace growth measures with relative total shareholder return or TSR. With this alternative, the board does not have to set targets for vesting.
Speaker 1: Oh, okay.
Speaker 2: LTI market practise is for vesting to start at median and full vesting is recorded at the upper quartile.
Speaker 1: And the fourth alternative.
Speaker 2: The fourth structural alternative is to replace performance contingent LTI with time or service-based restricted shares.
Speaker 1: Right. So the board director takeaway here is that board directors can utilise four structural alternatives for incentive plans when operating in high inflation environments.
Speaker 2: Yes. Now, we transition to how the equity granted within these plans is calculated at the grant date. The way equity is valued fundamentally alters the structure of the remuneration package.
Speaker 1: We consult Guerdon Associates’ articles published in March 2016 for this analysis. There is a distinction between face value and fair value.
Speaker 2: There is. Face value is the number of rights multiplied by the share price at the time of grant.
Speaker 1: And fair value incorporates discounts for dividends forgone.
Speaker 2: Yes. Guerdon Associates’ original research outlines why this distinction exists in practise. Proxy advisors use face value as the benchmark equity value. It has become a common practise for listed companies when disclosing how grant size is determined. So let us map out the calculation process.
Speaker 1: Let us do that. If an executive has an LTI entitlement equal to 50% of fixed pay and fixed pay is $1 million, then the LTI entitlement is $500,000. If the share price is $1, then 500,000 share rights are granted.
Speaker 2: But the face value of a share includes the expectation of a dividend. Whereas most LTI grants have no dividend entitlement. Guerdon Associates’ articles state that 80% of ASX 100 companies have a yield between 3% and 8%.
Speaker 1: Let us consider an example based on a $500,000 face value grant. Company A offers no dividends. At an 8% yield over four years, the present value is $363,075. Company B offers dividends. The present value is $500,000.
Speaker 2: Yeah. The regulatory framework mandates this calculation approach. The Australian Accounting Standards Board requirement for equity fair value lists dividends forgone as a required input into the valuation process. AASB2 application guidance B34 states that when the fair value of a share grant is estimated, the valuation is reduced by the present value of dividends expected to be paid during the vesting.
Speaker 1: Let us think about buying a coffee machine.
Speaker 2: A coffee machine.
Speaker 1: Yes. Face value is the price printed on the box. Fair value accounts for the fact that one machine includes a four-year supply of free coffee beans.
Speaker 2: Representing dividends,
Speaker 1: Right. Representing dividends while the other does not. Even if the box price is the same, the actual fair value to the recipient is different.
Speaker 2: That is a helpful way to look at it. Building on that concept, if the board policy is to grant equity to the value of 50% of fixed pay,
Speaker 1: Which is $500,000 on a $1 million fixed pay.
Speaker 2: Yes. To then make a grant with a value of $363,075 actually implies a policy of 36% of fixed pay.
Speaker 1: Wow. Benchmarking on a company policy basis comparing stated company policy is inaccurate if one company includes dividend equivalents and the other does not.
Speaker 2: Yes.
Speaker 1: Guerdon Associates’ original research notes incorporating a right to dividends makes the grant capital neutral. There is no incentive to push down dividend yield in favour of share price appreciation.
Speaker 2: To quantify this impact for a CEO with fixed pay of $1 million and STI and LTI opportunities of 50% of fixed respectively while incorporating dividends represents an increase in maximum remuneration opportunity of between 2% and 5%.
Speaker 1: Okay.
Speaker 2: This assumes a yield between 3% and 8% and a three-year performance period.
Speaker 1: So, the board director takeaway here is that benchmarking LTI policies requires adjusting for dividend entitlements to compare stated policy values with actual grant values on a like for like basis.
Speaker 2: Yes. So we have established general fair value adjustments regarding dividends. Now, we examine the specific valuation methodologies utilised for market-based performance measures.
Speaker 1: For this, we look at Guerdon Associates’ articles published in March 2017. These articles detail the Monte Carlo simulation methodology.
Speaker 2: Guerdon Associates’ original research traces the foundation of this methodology. It references a 1913 observation at the Monte Carlo Casino where a roulette wheel landed on black 26 times in a row.
Speaker 1: Wow.
Speaker 2: Landing on black 26 times is a single outcome within millions of possible combinations.
Speaker 1: Guerdon Associates’ articles record that Robert Brown observed grains of pollen executing a continuous random motion, which became Brownian motion.
Speaker 2: Yes.
Speaker 1: Norbert Wiener utilised logic to apply this to simulate a stock’s return.
Speaker 2: Yeah. Today, the Monte Carlo simulation methodology is used for market measures like share price appreciation or relative TSR. It simulates stock returns over a specified time period.
Speaker 1: It records the run as a single outcome and repeats the process millions of times. It calculates the average across all recorded outcomes to arrive at the expected value.
Speaker 2: How does the simulation account for changing variables over time?
Speaker 1: Think of predicting a commute time. You simulate the drive millions of times considering changing traffic lights, weather, and accidents along the road. The expected average commute time is the average of all those simulated drives rather than measuring the distance once.
Speaker 2: That makes sense. Because the simulation runs over a defined time period, it allows inputs such as volatility to vary over the defined time. Volatility decays from the current level to a long-term level over the simulation period.
Speaker 1: And a performance test is applied. And the vesting outcome and stock price are recorded within each simulation. The expected value is reached by taking the average across all simulations.
Speaker 2: Yes. So, the board director takeaway is that Monte Carlo simulations provide a valuation methodology for equity grants incorporating market measures by averaging simulated stock return outcomes.
Speaker 1: Returning to a specific variable identified in the fair value discussion, dividends. We review how frequently they’re actually included in equity grants.
Speaker 2: Guerdon Associates’ articles published in August 2025 examine executive incentives that include dividends with their STI and LTI share rights. An incentive which has value contingent on both share price and dividends is contingent on total shareholder return.
Speaker 1: Total shareholder return, or TSR, calculations assume dividends are reinvested.
Speaker 2: Yes.
Speaker 1: A dividend earned in year one of a three-year incentive is reinvested and earns compounding dividends.
Speaker 2: Guerdon Associates’ original research evaluates financial year 2024 ASX 100 CEO incentive grants to determine how companies include dividends.
Speaker 1: Okay.
Speaker 2: Incentives are considered to have dividends included if the instrument utilised includes dividends. If dividend equivalents are paid after vesting on the proportion that vests, if more instruments are allocated at grant to account for dividends forgone, or if the equity allocation basis accounts for dividends.
Speaker 1: That is quite comprehensive. Can you break down the differences across the ASX tiers, according to Guerdon Associates’ original research?
Speaker 2: I can, in the ASX 20, 100% of deferred STI and service equity includes dividends.
Speaker 1: Wow.
Speaker 2: And 65% of LTI includes dividend.
Speaker 1: Okay. We look at the ASX 50.
Speaker 2: In the ASX 50, 27% of deferred STI equity has no dividends. And 59% of LTI has no dividends.
Speaker 1: And the ASX 100.
Speaker 2: In the ASX 100, 73% of deferred STI includes dividends. 41% of LTI includes dividends. As the sample widens from a ASX 20 companies to ASX 100 companies, the prevalence of dividend payments across all incentive types decreases.
Speaker 1: Guerdon Associates’ articles detail the type of dividend payment by incentive. Short-term equity incentives typically include dividends.
Speaker 2: Yes.
Speaker 1: This is a function of shares being more prevalent than rights in these plans. Shares provide dividends, which are paid out during the vesting period on the understanding that the executive has already earned the shares.
Speaker 2: Yeah. And long-term incentives, such as performance share units, vesting based on performance and other restricted share units, vesting based on service typically provide an equivalent payment upon vesting.
Speaker 1: The board director takeaway is that the inclusion of dividends within equity plans varies by ASX tier and incentive type, which affects the overall structure of their remuneration package.
Speaker 2: Yes. So we cover the likelihood of vesting, the impact of high inflation on target setting, the distinction between face value and fair value, Monte Carlo simulations, and the prevalence of dividends.
Speaker 1: Before we conclude, here’s a final thought to explore on your own. How might the rapid advancement of artificial intelligence and machine learning alter the variables fed into valuation methodologies, and the future structuring of these performance targets? Thank you for joining the Guerdon Associates podcast.