While anticipated by most boards we work with, and only just now being realised by some in the broader community, the impact of COVID-19 will extend far beyond the time it takes for a successful vaccine. Governments, businesses and consumers will have greater debt than that caused by the GFC in 2007-08. The capacity to invest, build, and grow will be more limited. Reform to improve productivity in Australia, and that of our trading partners, is uncertain.
In fact, much of what the future holds is uncertain. Many remuneration committees are finding it impossible to set longer term performance targets.
The recent guidance from the UK Investment Association suggests a few alternatives (see HERE). However, all of these alternatives assume that regular performance-contingent LTIs will resume because, at some time over the next 12 months, things will settle down enough to make decent forecasts.
What if this is not the case? Indeed, some may say it never was the case. That is, forecasting over 3 or more years is fraught. Hence why so many prefer relative TSR as a measure, despite its limitations (for example, see these old chestnuts from 2006, when articles were shorter, HERE, HERE and HERE).
There is an alternative to granting executives LTIs – but, it comes with a warning.
However logical and rational this reasonable alternative may seem, some investors will not like it, simply because it means ditching long term incentive plans. Even the UK Investment Association, in its recent COVID-19 remuneration guidance, did not allude to this alternative, even though it features as an alternative in its letter to remuneration committee chairs in 2019 (see HERE). And, additionally, the alternative approach is backed up with research by the independent UK think tank The Purposeful Company (see HERE).
So, that’s the warning – what is the alternative?
It is, simply, restricted shares (or, for tax reasons in Australia, restricted share units). No performance measures. Just time-vested. And the time-vesting is long. It could cover a business cycle. The restricted shares (or RSUs) are, providing an executive is good, guaranteed. An executive need not be retained in service over the period to vesting.
This alternative approach to the traditional LTI acknowledges:
- Setting valid and reasonable long-term performance targets is too difficult – lacking in forecasting precision, with outcomes open to challenge by any one of the stakeholders
- Choosing specific performance measures to the exclusion of others crimps agility and responsiveness.
- LTI performance periods of 3 years are really short term, given strategies take a long time to bear fruit.
- Institutional investors are, for the most part, having to hold a company’s shares for the longer term
- There is a preference for long-term sustainable performance by owners (i.e. pension and superannuation funds)
- Three-year performance periods and short CEO/executive tenures encourage executive behaviour that contributes to excessive risk taking and price volatility
UK investors are now more accepting and have supported this alternative approach. Proxy advisers even have specific UK guidelines that consider the use of restricted shares. The ASX is dominated by cyclical businesses that, by their nature, have to think outside of three-year windows (e.g. banking, mining, and energy companies).
The preferred time to introduce the restricted shares approach to replace traditional LTIs would be when performance is good, with high traditional LTI vesting that the lower value restricted grants would replace. That timing would bring along some of the more sceptical investors.
These are not good times. But, given that the future is so uncertain, the underlying rationale is right for now. Think about it.© Guerdon Associates 2023 Back to all articles