Egan Associates monitors incentive trends, keeping track of the performance hurdles that Australia’s top listed companies employ.
Annual reports are now being released for the 2016 financial year and we will be updating our data on long term incentive plans, making it a good time to reflect on the year that has passed.
Of the top 300 companies ranked by market capitalisation at 30 June 2016, over 10% had no traditional performance-based long term incentive plan or provided no details on their long term incentive plan.
In some cases, a deferred short term incentive scheme or similar was utilised to provide alignment between executives and shareholders. In other cases, ad hoc grants of equity such as options were provided as an incentive to executives with no performance hurdles attached.
Where a traditional plan was described, the following attributes were found:
LTI Plan Instrument
Only 2% of companies used cash for senior executives in long term incentive plans (this increases to 5% if phantom share plans or share appreciation rights are included). Approximately 3% utilised loan-backed share plans.
Around 20% of the companies offer options as part of their long term incentive plans (often alongside performance rights or other equity types), with the proportion much larger for companies ranked 101-300 than those ranked 1-100. The remainder of companies offer performance shares or rights.
LTI Performance Period
Most companies’ long term incentives stretched to at least three years, although partial vesting might occur after one or two years. A maximum performance period of four years was chosen by around a sixth of the companies. A five-year performance period was utilised by less than 5% of companies. A number of organisations had poor disclosure, making it difficult to determine the length of their performance period without making assumptions from AGM grant approvals.
LTI Performance Hurdles
Over half of the 300 companies made use of a relative TSR measure. The proportion of top 100 companies utilising the measure was closer to 70%, while in companies ranked 101-200 it was around 50% and for those ranked 201-300 around 30%.
The majority of companies employing relative TSR used a tailored measure, whether selecting a small group of peers with similar business operations, or tailoring an index to exclude certain industries or overseas based companies. After that, the next biggest group used an unadjusted broad index, such as the S&P/ASX 100. A smaller group used a set industry-specific index.
Over a third of companies used an EPS measure, with a relatively equal distribution across the top 300 companies.
EPS growth targets ranged from thresholds of around 1% to maximums of up to 25%. The median threshold was around 6% and the median maximum was approximately 10%, with larger companies having lower targets than those ranked towards the bottom of the 300 examined companies. No companies ranked in the top 100 by market capitalisation had targets over 20% per annum.
Healthcare companies displayed the highest median EPS growth threshold, while Information Technology companies had the highest median EPS growth maximum. Utility and Energy companies implemented the lowest median EPS growth thresholds and maximums.
Almost 15% of companies used a measure such as Return on Capital, Return on Investment, Return on Equity or Return on Assets. A smaller number disclosed profit-based hurdles, fewer again disclosed industry or company specific hurdles (at times non-financial). Revenue, share price and cash flow hurdles rounded out the group.
Globally there has been a significant amount of comment on the effectiveness of long term incentive plans, as well as concern about the homogeneity of long term incentive plans, which has in part been attributed to companies’ concerns of going against proxy advisor preferences for certain hurdles, such as relative total shareholder return.
It is Egan Associates’ understanding that proxy organisations and institutional investors acknowledge that Directors understand their company best and appreciate the value of company specific hurdles if well disclosed and explained. Companies should be independent in developing customised hurdles if they have a clear idea of what would best work for their management team and reward shareholders over the longer term.
It is important for Boards to keep in mind that most investors and proxy advisors prefer plans that will align executives to shareholders and will motivate executives to produce the best results from a shareholder’s point of view – it is always advisable to consider whether bespoke plans meet this brief.