Eight Examples of Non-standard Incentive Schemes

Most large Australian companies adopt a standard remuneration framework:

  • fixed remuneration – consisting of salary, superannuation and non-monetary benefits
  • short term incentives (also known as annual bonuses) – payments based on performance against targets over a 1-year performance period, with a portion of the payment deferred for one or two years
  • long term incentives – normally granted as equity and contingent on 3- to 5-year performance against predetermined conditions.

Unconventional incentive schemes

Yet such a framework does not fit the requirements and strategy of all companies. We examine eight companies that have not followed this framework.

  1. For retention during challenging conditions

Worley Parsons has avoided the traditional annual incentive plan, instead adopting a scheme where the STI is split into two, with each portion depending on performance against different conditions:

  • Two thirds of the opportunity is delivered as cash, based on executives’ meeting performance conditions.
  • One third of the opportunity is delivered as performance rights with a vesting period of two years pending a share price performance hurdle. No performance rights vest if the share price at the end of the two-year performance period is equal to or less than half of the share price at the beginning of the performance period.

If this gateway is exceeded, the number of shares that an executive receives is calculated using the following formula:

Number of shares = Number of rights granted x Share price end / Share price beginning

The maximum number of shares that an executive can receive is double the number of performance rights granted, which is achieved if the share price doubles over the period.

When announcing the introduction of the plan in the 2015 annual report, Worley Parsons’ former Remuneration Committee Chairman John Green said that the company had “concluded that while company performance must remain the driving force in determining short term incentives, it is also important to appropriately reward our people for significant achievements in delivering on our strategy”.

The company listed its reasons for introducing the non-traditional performance rights scheme, saying it would:

  • provide executives with a clear goal – the increase in the Company’s share price – more closely aligning their interests with those of shareholders;
  • have the potential to be a stronger executive incentive than the prior deferred equity component; and
  • have the potential to increase executive shareholding “skin in the game”.

Current remuneration committee chairman Jagjeet Bindra stated at the 2016 AGM that Worley Parsons competes globally for key employees and “must consider structures that are outside Australian pay mix norms”. He also noted that by separating the cash and equity components of the STI award, the retentive and motivational value of the incentive plan was increased.

Worley Parsons received some negative feedback about this plan from proxy advisors, though not enough concerns were raised to cause a strike. Bindra stated that Worley Parsons would consider feedback, but that the company believed it had the mandate to implement the scheme due to the positive remuneration report vote in 2015.

  1. To encourage a performance culture and attract staff in a highly competitive employment market

Macquarie Bank has a very low proportion of total reward paid as fixed remuneration, with a much larger variable remuneration opportunity comprising annual bonuses and long term incentives. While the long term incentive is fairly standard, the annual bonus is less so.

Macquarie Group has utilised a profit share pool for its bonus scheme for many years. The pool is determined annually regarding Macquarie’s earnings over and above the estimated cost of capital. The Board has discretion to adjust the pool up or down to reflect factors such as risk and compliance and staff retention risk. There is no maximum incentive award.

A significant proportion of the profit share pool allocated to employees (increasing with seniority) is deferred for up to seven years:

  • as restricted shares in the group, or
  • As a notional interest in Macquarie Group equity funds.

The high level of deferral was implemented following the global financial crisis in an effort to meet regulatory requirements and improve shareholder-staff alignment.

While there is criticism of the level of Macquarie Group’s remuneration – for example from UBS, which states that the group’s earnings per share could be significantly improved if the group reduced remuneration costs – the system also has its fans. For example, Ownership Matters Principal Martin Lawrence has spoken out in favour of the remuneration structure.

“This system encourages management to act like a shareholder,” he told the Australian.

The Australian Shareholders Association has also given the framework its stamp of approval after much consideration:

“Whilst the author of this report coined the phrase “Millionaire Factory” for Macquarie Bank back in 1997, after many years of debate at AGMs we have come to accept the contribution made by the bank’s unique remuneration arrangements to its success. There is no other Australian listed company with a greater element of profit-based or at risk remuneration. Equally, there is no investment banking CEO in the world with as much restricted equity bonus payments as Nicholas Moore. He must wait up to 7 years to collect his annual STI and even then it comes as stock,” it wrote.

Less than 2% of votes were cast against Macquarie’s remuneration report in 2016.

  1. To reduce complexity and align executives with shareholders

Seek does not have an annual bonus scheme at all. Instead it offers fixed remuneration, which comprises cash and performance rights (which vest after 12 months and are restricted for a further 12 months), and offers a long term incentive scheme.

Seek stated in its annual report that it believed STIs to be flawed:

“Business outcomes are rarely the result of effort by Executives in a 12-month period. Profit outcomes usually reflect market conditions and/or the impact of executive decisions in prior periods. Short-term priorities can change quickly and we believe that remuneration schemes with pre-determined targets can undermine value creation. Rather than focus on fixed targets, we want our Executives to adapt to our fast-paced environment and make decisions that create long-term and sustainable value.”

The vesting of Seek’s LTI is based on absolute share price with a cliff vesting schedule, which the company believes is appropriate due to its simplicity and also because it keeps executives’ focus on the creation of shareholder value.

Seek also allows executives to choose whether they would like to be granted options or rights under the LTI depending on their own personal circumstances.

Seek explains that by doing this “we are trying to address the ‘boom/bust’ problem that exists in the long-term portion of many remuneration schemes. If Executives work hard and the share price has grown and beaten market averages, we want the LTI to pay out. That Options or Rights appear more attractive to Executives at particular points of the economic cycle is not a concern for us as long as the payout only occurs if shareholders have also done well.”

Seek received almost 20% of votes against the remuneration report in 2015. This reduced to under 10% in 2016. Tatts will be implementing a similar scheme to Seek in 2017.

  1. To support a transformation

After the appointment of Myer CEO Richard Umbers, Myer embarked on a transformation program to boost growth. The aim was to target sales growth and improved profitability, which would then lead to increased earnings and shareholder returns. To align incentives to these objectives, the company instituted an LTI which comprised:

  • an initial grant vesting after three years, with resulting shares restricted over one and two years after vesting. The performance hurdles for this grant were growth in sales per square metre and return on funds employed.
  • an additional grant that would only be made if the initial grant vests. 50% of the number of initial performance rights that vest would be granted. This grant would also have a three-year performance period, with relative TSR and EPS growth as performance conditions.

The entire scheme measures performance over a 5-year period.

Interestingly, the LTI grant in the 2016 AGM appears to have a more traditional structure with ROFE, relative TSR and EPS growth as performance conditions for a three-year performance period.

Myer just missed a strike in 2015 (mainly due to payments made to outgoing CEO Bernie Brookes) and received approximately a 15% adverse vote in 2016.

  1. To encourage long term vision

Flight Centre’s remuneration consists of fixed remuneration, STI, long term retention awards and returns from executives’ investments in the business.

Like Macquarie Group, Flight Centre’s annual incentives provide executives with an uncapped share of profits, but awards are made on a monthly basis. Flight Centre notes that this structure allows the company to review and amend targets during the course of any given year.

Long term retention awards vest after three years’ service, with no other performance conditions. Further “matching” awards vest later, to encourage loyalty and long service.

The most interesting feature of Flight Centre’s remuneration structure is its ability to invite executives to invest in unsecured notes for the group’s businesses. These notes provide the executives with a variable return that is tied to the individual business’s performance.

Such a scheme addresses one key criticism of traditional executive pay schemes that they have an upside but no downside. Flight Centre executives involved in the business ownership scheme are exposed to business risks as well as business gains.

For selected executives, Flight Centre may also choose to make a one-off payment based on a multiple (five to 15 times) of the abovementioned business returns. If the executive redeems the note after five to ten years, they will be awarded with five times the final year’s return on the note. If the executive redeems the note after ten years but under 15 years, they will be awarded with ten times the value of the final year’s return on the note. Executives must redeem the notes after 15 years, when 15 times the last year’s return will be awarded. Not all executives will be offered the 15-year multiple option.

When explaining the philosophy behind its remuneration framework, Flight Centre says it believes in providing its staff with ownership opportunities and encouraging them to behave like long term stakeholders in the company, thereby adopting strategies, discipline and behaviours that create longer term value.

Less than 2% of shareholders voted against the 2016 remuneration report.

  1. To align annual incentive awards with share price changes during the performance period.

Fortescue Metals has a non-traditional short term incentive plan. Instead of granting deferred equity at the end of the performance period when performance against targets is known, Fortescue grants performance rights at the beginning of the performance period as would occur for an LTI. The number of rights that convert to shares at the end of the financial year depends on performance. This ensures executives’ bonuses are exposed to share price movement over the performance period.

  1. To maintain line of sight for executives

Spanish-controlled CIMIC flew in the face of convention for long term incentives at large organisations, offering an options plan to executives without performance conditions. Instead the options vest after two years of service. There are also restrictions on exercise: 40% of the vested award can be exercised in the first two years after vesting and the remaining options in the third year.

In the annual report, the company stated its reason for the lack of performance conditions, noting that options had an implied performance hurdle in the exercise price and stating that “this structure was selected to provide participants with a clear line of sight as to the targets that must be satisfied and a stronger alignment between individual performance and vesting outcomes, ensuring a groupwide focus on sustained growth and group prosperity”. The exercise price of the options was the same as the grant date VWAP over five trading days.

Proxy advisors ISS and CGI Glass Lewis criticised the lack of performance hurdles. Yet the company did not experience a strike on its remuneration report, instead only recording a 15% adverse vote.

  1. To be globally competitive

In addition to a traditional remuneration framework, CSL provides an annual discretionary retention grant of notional shares valued at a percentage of fixed remuneration. The award vests after three years of service. The awards are made to attract talent and encourage retention. CSL received a strike on its 2016 annual report, partly due to concerns about these retention grants.

Chairman John Shine noted that CSL’s remuneration framework had been designed to attract talent in a global company.

“As a global organisation with operations in more than 30 countries, CSL is somewhat unique within the ASX top 10 as to the truly global nature of our operations. Over 90% of our revenue and profit is derived outside of Australia. Therefore, we need to, and have, a clear strategy to ensure that our remuneration practices are appropriate, appealing and competitive in each of the locations in which we operate,” he stated.

“Attracting and retaining highly-skilled executives who can successfully lead our complex and demanding operations around the world is critical to CSL’s future success. As such, it is important to balance consistency and relativity in arrangements for executives located in different geographies.” Seven out of nine of the key management personnel are domiciled outside of Australia, including the CEO.

“In the past, our remuneration practices have been based on a long-standing Australian model, with progressive, independently benchmarked modifications made over time to accommodate overseas market practices. This is not sustainable for our business into the future. We believe it’s simply about hiring the best people for our business, on terms that are fair, equitable and competitive in the markets in which they live and work,” he said.

Eyes will be on next year’s vote to see what, if any, changes CSL makes.

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