Giving staff a share: Latest governance considerations for LTIsGiving staff a share: Latest governance considerations for LTIs

No business can function without its people. “Take care of your employees and they will take care of your business”, says Richard Branson. But attracting and retaining staff can pose its own challenges. 

Share-based long-term incentive (LTI) schemes are one tool for that attraction and retention. They can align the interests of employees with shareholders and provide a tangible interest in the company’s long-term success. But LTIs are not straightforward. 

Here are a few things to keep in mind when implementing and governing an effective scheme.

Making sure the shoe fits

No LTI scheme is one-size-fits-all. The structure of any scheme should cater specifically for the company and its goals. 

All of the common structures we see in New Zealand, including share options, performance share rights, employee share loans and phantom share schemes, have different drivers. There are financial drivers, such as the exercise price or purchase price for shares, and non-financial drivers, such as the length of the period of service (aka the “vesting period”) necessary to receive shares. And – very importantly - there will be tax drivers, because the tax rules for LTIs are unique to New Zealand.

None of these drivers are simple. So carefully thinking through the impact a scheme will have is important.

One set of rules to govern them all

A Board may decide to establish a scheme in rapid time for a specific purpose.  For example, a bonus issuance of shares to a new CEO. The temptation is to do this on a bespoke basis, with minimal documentation. After all, it just needs a simple issuance of shares.

But this can cause problems. What happens if the CEO quits next week? What happens if a third party makes an offer to buy the company that the rest of the shareholders can’t refuse – does the CEO need to sell? What happens if the CFO wants shares on the same terms?

A well-documented set of specific scheme rules will cover (most) potential eventualities. It also provides consistency for all participants, current and future. Implementing different arrangements for different people can seem like a good idea; after all, a scheme that is tailored to the individual will most closely provide the right incentives for that person. But bespoke schemes can be difficult to understand and administer.

Discretion overload

That brings us to discretion. Some schemes have a clear vesting formula – e.g. based on share price growth or “Total Shareholder Return” – which provides the employee with a definitive outcome from their offer. But a pre-established formula cannot always provide the perfect incentives for every situation. Sometimes more flexibility can be helpful to ensure incentives adequately reflect an employee’s true performance. To cater for this, a scheme can provide the Board with discretion to adjust outcomes as they see fit.

However, all good things have their limits! It can be problematic to build high levels of discretion into an LTI scheme. Allowing for discretion can make the LTI scheme more difficult to administer and it can also encourage employees to lobby the Board in the hope of a better outcome. 

Also, it’s important to keep in mind that any exercise of discretion in an employment context must be made in good faith. This means that while the terms of a scheme may provide a Board with “absolute discretion”, often this isn’t the case in practice.

Bad behaviour

A trend we have recently seen in New Zealand – which reflects developments overseas, particularly in the UK and Australia – is to include malus and clawback provisions in the scheme rules. This enables entitlements to be reduced/cancelled (malus) or repaid (clawback) at the Board’s discretion if benefits for the scheme have been incorrectly calculated or, worse, if a participant in the scheme engages in undesirable conduct. These clauses often have a long tail, lasting well after the employee leaves, as often such behaviour is only uncovered later. While this would seem to add to the Board’s discretion, these clauses would generally only be exercised in exceptional circumstances, so they shouldn’t affect day-to-day operation of the scheme.

Maximising the scheme’s impact

To be worthwhile, an LTI scheme must include provisions that effectively link its entitlements to employee behaviour, company performance, or both.  While this may seem obvious, we often see companies implement and persist with schemes that only loosely provide a long-term incentive (e.g. a bonus issuance of shares without any vesting period), or schemes that - for reasons outside the employee’s control – very quickly are “out of the money” and cease to provide any incentive at all. 

Companies should set appropriate conditions or performance hurdles that must be satisfied for employees to receive entitlements under an LTI. Performance hurdles can be time-based (e.g. vesting over a certain period of employment), performance-based (e.g. vesting based on company or employee performance metrics) or based on a particular event occurring (e.g. a liquidity event).  

And maximising a scheme’s impact doesn’t end at its structure. Tools that allow employees to view, track and engage with their interests in an LTI scheme can also improve its impact by better involving its participants. 

In the end, a well thought-out LTI scheme can be an effective tool if companies put in a bit of work. Ensure the incentives are compelling. Keep the documentation consistent. Be wary of discretion. And keep it simple.

Disclaimer

The content of this article is general only and current at the time prepared - views and data are subject to change.  None of the information provided is investment, financial, legal or tax advice, and we aren’t liable for your use of the information in that way.