The company should “identify the key drivers, participants and how the plan should work to achieve its objectives,” she told HRD
. This includes looking at both short and long-term incentives as well as ways to engage stakeholders.
Employers typically have three types of deferred compensation arrangements to choose from:
- Share award schemes which grant a certain number of shares to the employee with restrictions to control disposal
- Share option schemes which grant the executive a right to purchase shares in the company at a predetermined fixed price/date
- Phantom unit schemes which grant employees a right to receive a cash payment equal to the gain that could be realised on notional shares (units) allocated to the employee
It is important to know the different choices available especially with regards to the structure of the plan and the benefits it can bring, Walsh said.
“Keep the scheme structure and processes as simple as possible,” she advised. “If complexity is needed, use FAQ sheets or guidance notes to clarify the essential points.”
Walsh also highlighted the following pitfalls when creating these types of arrangements:
- Blindly following convention or adopting a “one size fits all” approach
- Being too creative and implementing a complex scheme structure
- Failing to think about the long-term effects of the arrangement
- Forgetting about compliance needs and tax implications of these schemes
With the proper foresight and planning though, there are many benefits employers can gain from deferred compensation arrangements. For instance, both the share award and share option schemes align corporate and executive interests while promoting greater employee engagement.
Additionally, reward is linked directly to company valuation, there is no cash outlay required from the company and the scheme discourages executives from quitting before shares vest.
On the other hand, the phantom unit scheme ensures no former executives are later shareholders of the company and there is no dilution of owner control. This arrangement is also an excellent choice in jurisdictions where share options would raise tax issues.
There are a number of disadvantages that organisations should be aware of, Walsh says, particularly if the scheme is poorly implemented or managed.
“Typically, the business owner is giving the employee shares in the business. This is an ownership stake. It has a dilutive effect on the business owner’s own stake in the business, and may make the business less attractive if future investment from third parties is required.”
Having the employee as a shareholder in the business also means they “will be entitled to certain information rights in respect of the affairs of the business that would not be available to employees,” Walsh says. They may also expect some degree of input into dividend policy, she adds.
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When structuring a deferred compensation arrangement, it is best for companies to be clear about what they want to achieve, says Pattie Walsh, partner of Bird & Bird in Singapore.