Restructuring incentive schemes

In these very challenging times, companies are under considerable pressure to ensure that remuneration strategies incentivise good, risk-balanced management which align investors’ interests with those of executives and employees.

Many remuneration committees have therefore, particularly in the last 12 months, been reviewing the value of their incentive schemes and considering whether they need to be restructured to encourage executives and employees to work towards a turnaround and sustainable growth.

During the last recession, companies undertook option replacement programmes and re-based performance conditions.

However, companies would not want to replace existing awards without investor support and formal shareholder approval may well be a requirement. In the past, investors have on the whole been unsupportive of re-pricing or re-grant programmes, which the ABI guidelines state are “not appropriate”. Despite this, in the current climate, some shareholders have proven to be willing to work with companies and replacement programmes have again been the best solution.

Companies have also considered retaining existing awards, but re-basing the underlying performance conditions. Share plan rules often provide the company’s remuneration committee with a discretion to adjust performance conditions in specified circumstances, for example if the condition has become unfair, inappropriate or impossible to measure.

The grant of new awards under share plans will benefit from low share prices. This may make awards under approved Company Share Option Plans (CSOPs), Save-as-you-earn (SAYE) and Share Incentive Plans (SIPs) even more attractive at the current time.

Many companies have also implemented bonus deferral arrangements where cash bonuses are deferred into performance-related share awards. The deferred award only vests in the future depending on continuing service and company performance and is a very effective way of aligning the executive’s interests with long-term shareholder value. This may provide a useful solution for some companies with cash flow issues but who need to increase bonus opportunities in the short-term to re-incentivise their executives whilst increasing alignment with their shareholders’ interests. Bonus deferral could be operated in conjunction with a company’s existing long-term share plans.

When restructuring incentive and remuneration arrangements, care should be taken to ensure that employment law issues are considered, particularly where the restructuring requires a change to the terms and conditions of employment.

To change a contractual term of employment would usually require the consent of the employee in order that it does not constitute a breach of contract. An employee’s terms and conditions of employment may be express, implied or incorporated from other sources, e.g. collective agreements.

If the worst does happen, incentive schemes generally provide for all awards to vest or become exercisable on a liquidation of the scheme company. However, as it is very unlikely that any new shares may be issued on a liquidation, if an employee’s award is to subscribe for new shares, they will only have a cash claim.

Further, even if an award can be satisfied with existing shares, it may still be worthless as shareholders are last in the line to receive anything when a company goes into liquidation. Even if there are reserves left for shareholders once all creditors have been paid, options will only be worth exercising if their exercise price is lower than the value of the shares which may be acquired.

However, awardholders do at least walk away “scot-free” on a liquidation. For any employees holding nil-paid shares, the impact of liquidation is much worse: liquidators can call on them to pay up their shares in full.

The Norton Rose Group Employee Benefits Team has considerable experience assisting companies in restructuring their employee incentive arrangements. The Norton Rose Group Employment Team also has longstanding experience assisting companies with employment law matters and industrial relations.