ENSURING LONG-TERM COMMITMENT

The use of fixed-term service agreements used to be perceived as a benefit as well as a legally required written contract of employment. Such agreements were thought of as status symbols - signs of company commitment to its top executives. There is now concerted pressure to limit the terms of such contracts for 12 months or less; hence it is now necessary to look for other methods of ensuring directors' long-term commitment.

Share options, deferred bonuses or other long-term incentives are the three main ways in which remuneration policy can provide messages on the need for loyalty and commitment to the organization.

Their design  will reflect the different emphasis the company may wish to place on attraction, retention and motivation. Some examples are illustrated below.

Deferred Bonus Schemes

Some companies have adopted deferred bonus schemes under which part of the executive's annual bonus is deferred for, say, two years. The deferred element is converted into shares, each of which is matched with an extra, free share on condition the executive remains employed by the company at the end of the deferral period. Such a scheme is designed to reward: 1) annual (sometimes personal) performance, and 2) loyalty to the company, but does not differentiate on the basis of long-term performance (other than that reflected in the share price).

Share Option Schemes

Some companies have adopted share option schemes under which options are awarded to executives that may be exercised if long-term performance conditions are met. Typical conditions may be that the company's earnings per share (EPS) growth should exceed inflation by a set amount over three years and that the executive remains employed by the company at the exercise date. Such a scheme emphasizes: 1) share price growth (the option has no final value to the executive unless the share price increases), 2) loyalty to the company, 3) real earnings per share growth (which the executive may be able to influence by profit maximization, cost control, etc), and 4) share capital stability or reduction (eg through the buy-back of shares).

Performance Share Schemes

Some companies adopt performance share schemes under which executives are provisionally awarded shares. The release of the shares is subject to the company's performance, typically determined on a sliding scale by reference to the company's total shareholder return (a combination of share price growth and dividend yield) ranking against its chosen peer companies over a three-year period. Release is also conditional on the executive remaining employed by the company at the vesting date. Such a scheme emphasizes: 1) relative share price and dividend performance (hence even if the company's share price falls the scheme can deliver rewards to participants, provided the company's peers have done worse), 2) loyalty to the company, 3) value delivered to shareholders (in the form of share price performance and dividends), but does not link directly to business performance.

Economic Factors

Although share option schemes remain extremely common for a variety of reasons, the historically typical economic 'boombust' cycle means that they periodically fail when stock market values are low. During the last recession, Hay Group found that 70 per cent of companies in the FTSE 100 had executive options in issue that were 'deep underwater' (ie the share price was less than 80 per cent of the option price). During such times the popularity of other arrangements, such as performance share schemes, tends to grow. When the bull market returns, however, options become fashionable again as companies and their executives see the possibility of large option gains returns.