COVID-19: Long-Term Incentive grant sizes
Last week we published an article on the issues companies and remuneration committees will have to address regarding the impact of COVID-19 on incentives generally. Since then, we have had further conversations with some major proxy advisers and investors on the immediate issue of how companies should be granting awards under their 2020 equity-based long-term incentives.
We have previously highlighted that shareholders generally expect a ‘haircut’ to LTIP grants if the share price has fallen substantially (more than 25% is the accepted view) since the last award. The logic is that executives should not be “rewarded” by receiving more shares as a result of the price fall. Two of the major UK market proxy advisers have provided to Mercer some extremely helpful guidance for committees in the light of recent share price declines, as follows.
Investment Association – “The majority of members believe that if the share price fall is solely relating to COVID-19 market movements then they will accept that there does not need to be an adjustment to the grant size at the current time. Although it is important for the committee to confirm that they will look at the general market and share price response over the performance time to ensure that windfall gains will not be received on vesting. Investors will expect the Committee to use their discretion to reduce vesting outcomes if windfall gains have been received. Shareholders would expect any longer term individual share price underperformance to be taken into account though. So if the share price was down 30% in the year prior to the COVID-19 market reaction, an appropriate scaling back should be applied. There are a small number of investors who expect the committee to scale back awards based on COVID-19 alone.”
ISS – “On grant sizes there is…a mixed view, but…the majority [of investors] are more relaxed if the share price has only fallen in line with market sentiment due to COVID-19. The situation is obviously still very fluid so remuneration committees will need to be mindful of the potential for windfalls if share prices eventually recover. On this issue, ISS will aim to balance these perspectives. If it is obvious that shares are down because of COVID-19 rather than company-specific performance, there is room for flexibility in terms of the expectation that the underlying number of shares would be significantly reduced. We would still be considering performance up to the point of COVID-19, however, in addition to any further negative company-specific news that is not related to COVID-19. We would of course take into account any company-level explanations on these matters as well.”
The conclusion is that committees should consider the share price movement over the longer period (e.g. last 12 months) rather than just the recent movements in determining how grant sizes should be calculated. However, at vesting committee discretion should be considered if there has been a market-driven windfall gain, which could be assessed using other measures of relative or absolute performance e.g. share price, revenue, profit, ROCE.
The level of reduction (if any) that should be applied will depend on the circumstances, although it would normally be less than the level of share price fall. We will be happy to advise on this as required. Current practice amongst companies is quite varied – not least because the impact of COVID-19 on share prices has varied considerably by sector and there may also be company-specific factors to consider. We set out below examples of disclosures from two companies that have respectively reduced and not reduced award sizes.
Vesuvius plc (FTSE250 industrials) granted LTIP awards on 12 March when the share price was c.390p, having approved the awards at a February meeting when the share price was c.437p. The Committee used the earlier higher price (437p at the time of the February meeting) as the basis for calculating the number of shares, effectively imposing a c.10% haircut following the 10% decline in share price since the approval date. Note: the share price used to calculate 2019 LTIP awards granted in March 2019 was 608p, and today, the Vesuvius share price is 350p
Barclays plc (FTSE100 bank) granted LTIP awards on 9 March when the share price was c.124p (discounted to reflect no dividend accrual), following a decline in the share price from c.180p only 2 months earlier. Note: the share price used to calculate 2019 LTIP awards granted in March 2019 was 123p, and today, the Barclays share price is 89p. Commentary made at the time of the RNS announcement suggest that the Committee may apply discretion at vest if windfall gains result from a bounce back in share price: “While the share price has trended lower recently due to various global factors, we believe that these are mostly not specific to Barclays. It is also noted that under the LTIP for Executive Directors, the Committee has full discretion to ensure that the final outcomes are warranted based on the performance of the Group in light of all relevant factors and that there have not been any windfall gains.”
Finally, we would note that consistency is important here. If executives are being treated favourably (i.e. by not reducing awards) then investors may scrutinise wider business actions that have had a negative impact on staff generally (e.g. redundancies, working hours reductions etc.). And other equity plan participants should clearly be treated no worse than the Executive Directors.
As always, if you would like to discuss this or any other remuneration issue please do not hesitate to email or phone me or any of the team. The market mood on how Committees handle incentives in this environment will likely vary based on how severe, and long, the hit to shareholder value becomes.
This briefing is for general guidance and does not necessarily cover all areas of the topics included in this briefing. It is not designed to give legal or other professional advice.