Sign-on payments nearly always give rise to tensions – for the board, with investors and proxy advisers, and, of course, for the executive who may be leaving something behind!
Sign-on payments were identified as a potential problem during the GFC as international bank regulators established compensation guidelines to minimise risk. For example, an individual who moves jobs could receive a “buy-out” award from a new employer to cover variable pay forfeited on leaving their previous employer. However, the “buy-out” would not suffer from any application of malus or clawback that might have applied to the original variable pay elements had she remained in post.
The Financial Stability Board (FSB) wanted global regulators to prevent serial job-hopping risk takers, from garnering rewards while sowing the seeds of prudential havoc.
The Australian Prudential Regulation Authority (APRA) considered this in paragraphs 82 to 83 of the prudential practice guide on remuneration (PPG 511 see HERE). With a strong supervisory capacity, APRA has not seen the need to go further.
This has not been the case elsewhere in the world, perhaps because elsewhere there is more evidence of systemic failure and poor prudential supervision. The result is a heavier regulatory hand that tries to address these issues. One of these approaches has provided the inspiration for a board checklist to ensure executive sign-ons are better governed to meet greater levels of external stakeholder scrutiny on executive contracts, and avoid any excuses for regulation. This is a new section being considered by the UK Prudential Regulation Authority for its CRDIV Remuneration Code, which deals specifically with “buy-outs” (for those fearing the dread hand of excessive regulation – see their example HERE).
Guerdon Associates’ suggested board remuneration committee sign-on/buy-out checklist is:
- Have the prospective recruit provide all documentation on their current employment, incentive arrangements, including current holdings, invitations and rules.
- Minimise the use of cash in favour of equity. Equity holdings (or rights to equity) provide skin in the game while other equity builds up over time with annual grants.
- Have equity components independently valued. An independent valuation provides an arms-length assessment of the value of the unvested equity and avoids any undue influence from either side of the negotiation.
- Be prepared to provide transparent disclosures. An independent valuation should provide a rationale that can be used in disclosure documents.
- The valuation should be discounted as appropriate for the probability that grants will not vest, having regard for performance to the date of buy-out. In the case of a TSR test, this is relatively easy as data is in the public domain. EPS or capital efficiency tests can be undertaken on the last disclosed financials. However, analyst forecasts may also inform the probability estimate.
- The valuation should take into account whether or not there are dividend entitlements when determining the value of current holdings and the buy-out grant.
- Where possible, use like-with-like equity grants. For example, forfeited LTI grants are bought out using an LTI grant with the employer’s usual performance and vesting conditions. This reduces the risk of a large vesting outcome in future years, if performance is below threshold levels. Similarly, unhurdled, or service-based equity can be bought out with the same forfeiture conditions as deferred STIs.
- Buy-out terms should be “no shorter” than the terms of the forfeited awards with the previous employer regarding the duration of retention, deferral, performance and clawback arrangements.
- The buy-out award must have a provision that allows for malus/clawback if malus/clawback would have been operated by the previous employer.
- Performance based components bought-out should remain contingent on comparable performance terms