In this final post, approaches commonly used in market driven economies are summarised. Specific advice and help can be provided from any of the established compensation consultancies or specialists in the region.
Employee Share Options
The Option in the title gives the employee the choice (or option) of whether or not to exercise (take up) their shares and to cash them in at a profit at an agreed future date.
Employers award their key staff with these options which is a potentially lucrative arrangement for the employee and a cost free arrangement for the employer as options over shares are granted and accounted for at an agreed price at the outset and only vest after a period usually of three to six years following grant. Any increase in the share price is effectively paid for by the market. If for whatever reason the share price does not increase after the grant of options there is no requirement for the employee to exercise their options. Nobody is any worse or better off, the options are not exercised and the shares set aside to fund the scheme return to the company’s share capital. Given that many option schemes have an exercise period of up to six years however it is very unusual for the share price not to have increased in that time.
These are shares offered to key staff that will vest (become available) in an agreed period of time, usually three to five years after grant, subject to certain individual performance levels being achieved. For senior executives performance levels can be corporate performance such as pre-defined levels of profit, market share, growth, acquisition etc. However it is advisable only to make corporate targets the performance measures for the most senior executives and those that have some impact upon total business performance.
Once agreed performance targets have been achieved the shares are offered, possibly at a discount, and they become the property of the employee.
Withholding a percentage of bonus for up to five years was one of the recommendations to come out of the review of banking reward practices in 2008/9. One of the problems banks’ faced in the pre-crisis years was the way in which reward practices, especially the substantial bonuses available, determined employee behaviour. High levels of risk were taken to generate high levels of bonus, unfortunately that led to a short termism mindset which meant that by the time the risks had manifested themselves bonuses had been paid leaving a deficit that had to be recovered, absorbed or at worst written off.
The challenge was to apply greater levels of risk to those taking the risk in order to better focus their minds on what was best for the bank and its shareholders; hence the arrival of deferred bonuses. Up to 50% of the annual bonus was to be deferred for between three and five years subject to ongoing levels of performance and the performance of certain investment decisions taken previously.
It is not only deferred bonus that acts as a retention tool but deferred shares as well as has been discussed. Should an employee leave during the term they walk away from all their deferred bonuses and options.
What if we don’t have shares to offer?
Finally, there are a number of family owned businesses that can’t or prefer not to dilute their share capital by inviting non family members to become shareholders; what are they to do?
Phantom shares are often the best choice in cases such as these. Phantom schemes offer the chance to reward key staff with cash that mimics the growth in share price that would have taken place had shares been publicly traded. Individual schemes need to be designed to meet the particular needs of individual businesses, but essentially the value of the business needs to be identified and it is the growth in that value, year on year, that determines the value of the phantom share and consequently the level of payment to those staff in the scheme.
Phantom schemes are cash based and can therefore be quite costly. But in the absence of anything more substantial they are often the only choice available if privately held shares are not to be offered.
Finally I would urge you to discuss with your compensation advisor which approach might best suit your organisation. It may well be that none of the above is ideal in your case but the chances are that one of them or a variant of one of them will be suitable.
Tim Knight has spent much of the past 28 years living and working throughout the GCC and until July 2011 was Head of Compensation & Benefits at National Bank of Abu Dhabi, a position he held since 2007. During that time he initiated various changes including the introduction of one of the first ESCA approved employee share programmes.
Do you like this article? Sign up to receive our newsletter for HR insights delivered to your mailbox.