What Price Ownership? Issues With Executive Share Ownership Requirements.

Most respected governance bodies in Australia do not prescribe shareholding requirements for executives in the companies they run, in contrast to similar bodies in the UK and the USA.  On balance, this is a good thing, as we will conclude at the end of this article.

In the UK, the Combined Code states that it is desirable that executives hold shares after vesting or option exercise for at least 12 months.  Several US governance bodies recommend that executives own company shares.  For example, the NACD Blue Ribbon Report On Executive Compensation And The Role Of the Compensation Committee (available here) recommends that companies require executives to buy or own shares and create disincentives to selling them.  However, the report cautioned that “commitment, not dependency, is the goal” and that committees should avoid requiring executives to have too much of their net worth tied to company shares. 

The US Business Roundtable’s Executive Compensation: Principles and Commentary (available here) recommended that executives also acquire and hold a “meaningful” amount of shares.  In addition, it suggested that they acquire some of this holding through part of their incentive based awards. 

Partly as a result of these governance requirements, the number of US companies requiring senior executives to hold shares in their companies continues to increase, although holding guidelines remain fairly constant, with median CEO holding requirements at a little over 5 times salary for the 82% of public S&P 500 companies that have holding requirements.

Outside of the financial services sector, Australian companies, in contrast, rarely have executive shareholding requirements.  

Should Australian companies change?  What is the effect of these holding requirements? 

On the whole, these holding requirements would encourage a tendency to be more risk averse.  The extent would depend largely on the two primary factors of share volatility and the proportion of personal wealth tied to company ownership.  The breadth to which these factors range in the real world requires remuneration committees to question in more depth recommendations for adopting a policy of median practice. 

For example, care should be taken if shares are highly volatile, and the company has very high revenue and earnings growth potential. That is, it may be unwise to encourage the CEO of, say, a high potential technology company to be more risk averse through shareholding requirements when shareholders expect entrepreneurship.  It may also be difficult to attract a capable CEO required to have a significant proportion of his/her personal wealth locked into a relatively risky investment.  In this case it may be not only fairer but also prudent to define holding requirements as a proportion of profits on option or SAR exercises, rather than as a multiple of salary.  With adequate analysis, the executive’s holding requirements could be adjusted to the likely maturity curve of the company’s shares over time.

The converse also applies.  A mature company with low volatility and slow revenue growth prospects may consider establishing executive ownership requirements substantially higher than median standards.  Typically, such companies may seek higher dividend strategies to deliver improved shareholder returns.  These may be sought through better operational earnings and prudent acquisitions with resultant cost savings.  A high ownership requirement will help focus these executives on delivering better shareholder value.

So, on the whole, Australia is fortunate that the main governance guidelines do not prescribe executive share ownership because the effectiveness of such a requirement would vary with company capital and business strategies.

© Guerdon Associates 2024
read more Back to all articles