Equity proving obtuse in age of disclosure

CONSTANT PRESSURE from shareholder activist groups to increase performance hurdles for the variable component of Australian executives’ pay packets is pushing up the level of bonuses being demanded, a recent study has found

CONSTANT PRESSURE from shareholder activist groups to increase performance hurdles for the variable component of Australian executives’ pay packets is pushing up the level of bonuses being demanded, a recent study has found.

Revealed at a boardroom lunch put on by specialist financial advice and investment management company ipac, the findings were part of a preview of the results of the annual review by Equity Strategies of share plans in the Top 200 ASX listed companies. Of the Top 200, there were 40 new or amended plans approved by shareholders in calendar 2005.

According to Equity Strategies director Edward Wright, performance hurdles have again proven contentious, with a good deal of indecision evident among Australian boards as to the best method of share plans to utilise as well as how to expense them.

Nineteen companies adopted options plans, 15 adopted performance rights and 15 adopted other types of plans (including five restricted share/deferred bonus plans).

Of the 40 plans approved, 37 adopted performance hurdles. By far the most popular performance measure has been Total Shareholder Return (TSR) rather than Earnings Per Share (EPS), despite, as Wright pointed out, that EPS has always been the first question on analysts’ lips. Of those using TSR, 18 companies used a relative measure compared with an index of comparable companies, while the remaining five used an absolute value.

EPS has proven less popular, according to Wright, because of suspicion surrounding share price manipulation. However he contends that there is no evidence of share price or capital manipulation to meet EPS targets.

He also points out that the oft-quoted Enron example was not subject to any performance hurdles. However, there is clear evidence that as hurdles become more difficult to achieve, their value to the executives is diminished.

One of the main reasons for approving share plans cited by Australian boards in 2005 was their being used as a retention strategy. This has proven particularly prevalent in the mining and financial services sectors. The ageing workforce is also being mentioned increasingly regularly as a factor likely to exacerbate the skill shortage.

However, despite their use in this manner, share plans have not proven to be particularly successful. Instead, if an organisation targets a specific individual, if that person has a share plan with another company, it just raises the bar as to how much money is required to lure them into a new role.

In other words, if you stand to make an additional million by simply sticking around your existing employer, then before you would go to those wooing you, the first thing you’ll settle is getting that million, ideally up front.

Allocating value is becoming an increasingly important aspect of all share holder plans.

There is an incentive for companies to minimise the valuation to reduce the reported cost of the valuation. In 2005, there was a mixture of approaches to valuation.

Linking short-term and long-term incentives

A new trend has been the interlinking of the equity elements of a company's remuneration through provisions in a plan. At least five leading Australian organisations have elected to take this path including BHP Billiton, QBE Insurance, Lion Nathan and Woodside Petroleum. In the case of Woodside:

- Economic vale added (EVA) performance in a year determines the size of a total annual incentive pool to be distributed to participants.

- Each executive's individual performance is assessed in accordance with their applicable key performance indicators (KPIs) to determine his or her share of the pool.

- Forty per cent of the executive's allocation is paid in cash and sixty per cent divided into one-third time-vested restricted rights (i.e. no further performance condition applies) vesting after three years; and two-thirds TSR-vested performance rights; performance is first measured after three years and retested until year seven.

- The board can satisfy either of the rights in cash.

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