Executive incentives: what if the share price drops?
In a weak market, who wants to be an executive who relies on a strong share price to pay for the luxury yacht?
Between December 2017 and last month, the value of the Naspers shares owned by group CEO Bob van Dijk dropped by almost R1bn.
In addition, Van Dijk would have watched as around R800m leaked from the value of the Naspers shares that were allocated to him but that he does not yet own. His share appreciation rights were also looking steadily less attractive as the year progressed.
Van Dijk’s notional wealth recovered last week when global index firm MSCI decided not to exclude or reduce the weighting of companies that give certain investors higher voting rights than others. Naspers’s dual class structure gives the holders of unlisted A shares control over the company. His fortunes were also helped by the much-awaited rally in Tencent.
The combined effect was a 9.7% jump in the Naspers share price within 24 hours, the largest one-day increase in four years.
The reversal of the unsettling decline in the Naspers share price must have been a relief for all those shareholders who, before December, may have taken an ever-strengthening share price for granted.
It must also have been a relief for Naspers’s remuneration committee, which has often spoken of the need to offer extremely attractive packages to lure, and keep, apparently highly sought-after executives in this hi-tech business.
The committee may have been a little disconcerted that from an incentive perspective the real message from this year’s developments is that the best use of Van Dijk’s time would have been lobbying the MSCI decision-makers rather than focusing on finding the next great tech trick. The fact is, the bulk of Van Dijk’s wealth and that of most of his executive team is tied up in a share price over which they have little, if any, control. That’s a bit of a problem when the market is moving steadily upwards. When the market heads down, it becomes a serious challenge.
While Naspers represents an extreme case of what could go wrong with executive incentives when the share price drops, it is not the only company whose executives might be feeling a little less incentivised right now as the local equity market is hit by weak economic conditions.
There is much at stake. Typicaly, long-term share-based awards account for at least 30% of the value of an executive pay package.
Gerald Seegers, head of human resources services at PwC, says institutional investors are becoming more engaged on the issue. They want to see links between executive rewards and shareholder returns and they also want simplicity.
One scheme that demonstrates the flimsiness of the link is Tsogo Sun’s R200m loan to its top executives. The company is planning to bail out the four executives who benefited from an interest-free loan given to them in 2014 to buy shares at the same R25.75 price at which a controlling block was purchased from SABMiller, which is about R4 above the current market price. The bailout is part of a plan by controlling shareholder Hosken Consolidated Investments (HCI) to sell Tsogo Sun’s properties to Hospitality Property Fund and for union-aligned HCI to cover the R20m or so losses suffered by the four executives on their share purchases.
The precedent was set last year when Tsogo Sun paid former CEO Marcel von Aulock a R28.9m "ad hoc loss-of-office settlement", which more than covered the loss of around R16m on his share of the R200m loan, which had to be repaid after his departure.
The loan stirred up a lot of controversy at the time, with some unions slamming it as selective empowerment and inappropriately generous.
It was in fact considerably less generous than the traditional share option schemes and, unusually for executive remuneration schemes, carried downside risk. At the time HCI CEO Johnny Copelyn said the prospect of a share price fall represented a strong performance incentive for the executives. Now Copelyn says the proposed restructuring into three different entities means there’s no sense in having the previous incentive structure, which was based on just one entity, Tsogo Sun.
The Tsogo Sun minority shareholders aren’t impressed, so the bailout may not go through. Despite Copelyn’s explanation, the deal does fuel the suspicion that when it comes to remuneration, executives’ interests are rarely aligned with those of the shareholders.
A year ago Pick n Pay extended by 12 months the vesting date of share options allocated to CEO Richard Brasher when the share price failed to hit the required level for vesting.
The extension didn’t help, so Brasher lost out on one chunk of his option awards for reasons that had little to do with him.
Fortunately for Brasher he did have a lot of unconditional share awards.
Over at Woolworths, almost all of the share price weakness was down to decisions taken by a handful of top executives, so it was appropriate that over the past few years the share-based awards had little or no value.
Woolworths’s poor operating performance also meant there were no bonuses.
However, generous retention payments to a few key executives sheltered them from feeling the sort of loss suffered by shareholders.
For reasons that have almost nothing to do with SA’s executives, whole swaths of the JSE have been in weak territory for the past year or more and, with US interest rates set to rise, they don’t look like they’ll improve much in the near term. This grim outlook has accelerated a rethink of the long-held view that executives are responsible for share price movements.
With share prices flatlining or declining, remuneration committees have come to the view that executives should not be held responsible for share price performance.
Happily for their cosseted executives, they are shifting away from incentive schemes that rely on share price growth to generate rewards for executives. The new view has been gaining ground since the global financial crisis knocked equity values so hard it took two years for them to recover.
Shareholders of Eqstra, previously a unit of Imperial Group, were among the first to be made aware that executive and shareholder interests rarely align. In 2010 they bailed out their executive share purchase scheme to the tune of R53m after the share price tanked.
Instead of share options and share appreciation rights being allocated at current prices, executives are being awarded performance shares and restricted shares at zero cost.
One independent remuneration consultant says that to sustain belief in the largely imaginary link between executive and shareholder interests, total shareholder return is used when allocating the free shares.
The use of a comparator such as an index or a selected peer group means executives can still get generous payouts even when the share price tumbles — as long as it doesn’t tumble as steeply as the index or peer group.
So two things will remain certain: executives will score big no matter what happens to the share price; and alignment with shareholder interests is not guaranteed.