The last several years has seen many concerns being voiced about the complexity of current remuneration arrangements.
It was suggested, both in Australia and abroad (see HERE) that long term incentives were not “fit-for-purpose” and another model might work better.
This statement was accompanied by a number of proxy advisers acknowledging that “creative” incentive plans that were tailored to or better suited a company were just as palatable to them as long as they were properly disclosed.
Given this, several companies decided to retire their remuneration frameworks and embark on something new. Guerdon Associates reviewed a dozen of the most recent plans where companies had made the decision to diverge from the norm.
The most popular alternative to the traditional Fixed remuneration, STI, LTI remuneration framework seems to have become the combined incentive – where STI and LTI are rolled into one incentive plan. A one-year performance period determines the quantum of incentive payment, where part will be paid as cash directly, and part will be deferred into equity to vest at a later date.
In the simplest terms, these combined incentive plans seem to fit into two key categories.
1. After the one-year performance period is finished, the only requirement for vesting of or removal of restrictions on the resulting equity is time and/or service.
2. After the one-year performance determines the initial incentive amount, the number of equity instruments that vest are based on a further measure based on a long-term performance period.
Just over half of the companies with newly announced combined incentives imposed further performance conditions on a portion of the equity granted (the second type mentioned above).
The long term performance conditions ranged from a fully-fledged long term incentive type scheme with vesting conditions such as relative TSR and EPS (including the usual vesting schedule), to a gateway requirement or a statement that the company must meet threshold requirements by the end of the vesting period.
As performance is assessed over a period of 3 or more years, the combined incentive would be labelled a long term incentive. The reality is that while these plans’ final vesting is contingent on performance measured over the longer term, the initial amount granted is determined by short term performance. So the motivational focus is like an STI.
Implementing an achievable threshold performance gateway on the equity provides some assurance that the executive has not shot the lights out one year at the expense of subsequent years, acting as a form of malus.
While that these are the two main differences of combined incentive plans, the following details other differences between companies.
1. Proportion of combined incentive plans paid as cash
Most companies chose to pay approximately 1/3 to 40% of the combined incentive as cash. However, it varied from as little as 10% to as high as 100%.
2. Type of equity granted
Restricted shares, performance shares and performance rights were the alternatives adopted by the companies examined.
Performance rights and shares enabled companies to place further performance or service conditions on the granted equity.
Unless otherwise arranged, the former generally does not entitle executives to dividends or a dividend equivalent during the performance period, while the latter does.
Restricted shares were generally used to ensure full alignment with shareholders whereby dividends are typically received by the employee during the deferral period.
Some companies have granted performance shares or rights AND restricted shares.
3. Beginning of the equity performance period
Where there were performance conditions placed on equity after grant, the performance period started either with the initial 1-year performance period or at the start of the grant after 1 year.
Generally companies with a malus-type long-term performance condition started the equity performance period after the end of the initial 1-year performance period. Those with more traditional LTI performance vesting schedules started the performance period at the beginning of the 1-year initial performance period.
4. Service requirements
In order for performance equity to vest, employees generally needed to stay in employment until vesting date. A number of companies allowed good leavers to retain equity on foot.
5. Length of the equity performance period
Companies with an LTI-type performance condition and vesting schedule elected for three to five-year performance periods. Those with malus-type performance conditions preferred shorter performance periods of one to three years.
Equity dependent solely on service vested incrementally each year for up to four years after the end of the initial 1-year performance period. Restrictions on vested equity after vesting was sometimes used to extend control over executives’ shareholdings up to five years following the end of the initial performance period.
6. Length of the equity service period
Equity dependent solely on service vested incrementally each year for up to three years after the end of the initial 1-year performance period. Restrictions on vested equity after vesting was sometimes used to extend control over executives’ shareholdings up to five years following the end of the initial performance period. Under the deferred taxation rules, this restriction would enable taxation to remain deferred.
7. Annual performance period conditions
These are generally the same as could be found in any STI. NPAT, EBIT or EBITDA, ROE, ROC, Expense reduction, Health and Safety, Strategic Milestones, were examples of performance conditions implemented.
8. Size of incentive
Three of the four companies that chose not to implement long term performance hurdles on the equity sought approval by emphasising a reduction in overall incentive quantum. This reduction will likely be expected of them due to the increased certainty for executives of equity vesting.
9. Allocation basis
Where specified, equity was almost always allocated on face value based on the 5- or 10-day VWAP around the end of the financial year or the announcement of results.
10. Minimum shareholding policy
Some of the companies implementing combined incentive plans have done so in conjunction with announcing a minimum shareholding policy. Over half of the companies with a combined incentive policy disclosed a minimum shareholding policy, generally of at least 1 x fixed remuneration or base salary.
Alternatives to the alternatives
Combined incentives may continue to grow in popularity. In fact, the absence of much variation so far suggests that, for some companies at least, they may not be designed as being “fit for purpose”. Rather, they may be an outcome of replacing a traditional framework that did not work with something different that other companies are doing.
We know that some proxy advisers and investors, while open to new methods, need to be convinced that what is being suggested is, indeed, fit for purpose. We believe that this can be achieved, and not necessarily with new frameworks that appear to be as highly standardised as traditional frameworks.© Guerdon Associates 2023 Back to all articles