A growing practice in Australia is to hold back some of the executive’s bonus in shares. In a recent study, Guerdon Associates found that 70% of the ASX 20 and ASX 100 Resources companies have executive STI deferral features as part of their design. All deferrals utilised equity, such as restricted shares. This trend has been evident for several years, and it is likely that more companies will introduce it. Deferrals are service based. The most common deferral periods are 2 to 3 years. Typically, the vehicle used allows executives to defer tax for up to ten years providing the shares are not traded.

This practice has a number of benefits:

• The deferred shares serve to retain executives. If they leave at any point (other than retirement), they lose 2 or 3 years’ worth of deferred bonus.
• The better performers are more likely to be retained, as they have more to lose if they leave than “ordinary” performers.
• Executives build up their shareholdings in the company, and hence are better aligned to the interests of shareholders.
• Because of the build up in shareholdings, executives are better inclined to focus on sustainable longer term performance.
• Most designs of deferred shares take advantage of tax deferrals provided under Division 13A of the Income Tax Assessment Act, so are more valuable than cash, increasing their retention power.

Many UK and some Canadian companies go a step further. They provide an additional company “match” to the deferred bonus shares, encouraging executives to elect to defer more than the minimum required by the company. The extent of match is based on long term performance measures. More “match” shares are provided for better long term performance. In effect, this creates a useful bridge between short term performance and long term performance.

Companies seeking to introduce a deferred bonus share feature face transition issues. On introduction, all else being equal, the cash bonus received will reduce. To overcome this, the amount of bonus at target performance levels will need to be increased. To keep a lid on total remuneration levels, therefore, something else has to give. Given that the deferred shares will assist in keeping executives focussed on sustainable longer term results, it should be acceptable for the company to reduce the target amount of shares or options for the long term incentive.

While all companies’ situations will be different, we suggest management, boards and investors consider proposals such as these. At first glance companies introducing such a policy may appear to be increasing “short termism” because of the increase required in target bonus and the decrease in target long term incentive, but they are not.

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