It is not unusual for investors, directors and/or management to query the value of long term incentives (LTI) used for benchmarking purposes.
Investors and proxy advisers will generally benchmark what is granted to executives based on the number of equity instruments (e.g. rights) multiplied by the share price on the date of grant.
Yet, it is common practice for many companies to grant equity to the value of a percentage of fixed remuneration. They then work out the number of equity instruments to be granted based on a VWAP either leading up to or following the financial year end (generally 30 June).
Problem is, when there is a material difference in share price between the 30 June VWAP and the actual grant date share price, the value can vary significantly. People notice.
Consider, for example, a CEO who is entitled to $500,000 in LTI share rights each year. The company allocates its LTI equity based on the LTI value divided by the 5-day VWAP leading up to 30 June. If this is $1, the executive will be granted 500,000 share rights.
The company seeks shareholder approval at the AGM to grant 500,000 share rights to the CEO. However, when the grant is actually made in November, the share price is $2.
Therefore, the face value of the LTI at grant date (as used by many investors and proxy advisers) will be $1,000,000 and not $500,000. This value is double the policy amount.
The result is that investors and proxy advisers are unhappy at the oversized grant and remuneration is inconsistent with the company’s stated pay mix policy.
Of course, the share price may have moved the other way, resulting in an LTI grant value less than the stated policy value. Now your executives are unhappy.
And then there is the issue of expensing in accord with AASB 2 Share Based Payments. AASB 2 specifies that the cost to be expensed to be determined at grant date, with the “nominal” 30 June grant date again left without a leg to stand on.
There is a better way. And, it is more accurate, consistent and representative of the value granted to the executive.
Rather than specifying a number in the AGM Notice of Meeting, the company could provide the formula that it will use to determine the maximum number of equity instruments to be granted. For example:
Share rights to be granted = (fixed remuneration * LTI percentage) / 5-day VWAP prior to grant date.
In this way, the value of the LTI grant will:
- be in line with the way in which investors assess it
- closely align with the LTI policy value
- also align with AASB requirements
- significantly, will reflect a well-informed share price as it is based on a VWAP immediately following the release of results or immediately prior to the AGM; and
- will represent the value of the opportunity granted to the executive.
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