Change in Control – Is the Australian or US approach the better governance model?

While M&A activity has been minimal over the past two years, it is slowly increasing again and predicted to continue to grow when interest rates ease. Now, therefore, is a good time to review what happens to an executive’s incentives when a change in control (CinC) event occurs.

The treatment of unvested incentives when a CinC event materialises differs between the Australian and US markets.

In the US, around 88% of executives are subject to a ‘double trigger’ clause in their contracts or under company policy. This will determine whether accelerated vesting of incentives will happen. The double trigger usually has two requisite conditions:

  • a change in control event, and
  • the involuntary termination of employment of the executive without cause within a specified timeframe. The time between CinC event and termination varies and is usually in the range of 9 to 18 months.

In Australia, market practice varies from contracted accelerated vesting of all or a pro-rated portion of unvested incentives to board discretion having regard for the circumstances. There is no reference to termination. This stems from ASX LR 10.18, which prohibits an officer becoming entitled to termination benefits arising from a CinC.

The double trigger rule is mostly positive for US executives. It protects an executive from suddenly being terminated as soon as a takeover occurs, minimising the likelihood that a buyer will replace all executives. It creates a system in which US executives are neither excessively seeking, nor opposed to a sale of the company.

The opposite is true of the Australian approach, in which executives may expect an accelerated payday when a CinC happens, and still keep their job.

Proxy advisers have guidelines on the treatment of unvested incentives on a CinC. Proxy advisers, broadly, do not support automatic accelerated vesting on a CinC. Guidelines suggest a preference for pro rata vesting for the elapsed period of time, with a reduction in the overall vesting amount being expected. However, there is a range of arguments why this position of the proxy advisers is not necessarily good governance (see HERE).

It is not unusual for acquirers to limit the extent to which the target company board can vest unvested incentives, depending on the circumstances of the transaction.

So, which approach provides the better governance principles?

Ultimately, the hard baking within equity grants of a CinC resulting in accelerated vesting may give rise to conflicts of interest and lead to poor behaviour. It is suggested that the preferred approach in policies and incentive plans is for the board to retain discretion to determine the treatment of unvested incentives having regard for the circumstances of the CinC.

And the answer to the question? On balance it seems that in these instances, US practice is better governance.

© Guerdon Associates 2024
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