Opinion: Rethinking Long-Term Incentive Schemes – time to go beyond stock options?

by HRD15 May 2015
Long-term incentive plans (LTIP) are a key component of senior executive compensation in Singapore, yet Kevin Ong suggests it's time to get more creative with what's on offer.

Performance reward for executives is a sensitive issue. Experience shows that shareholders are concerned and even outraged when they perceive that poor or inconsistent performance is rewarded.
 
Long-term incentive plans (LTIP) are a key component of senior executive compensation. In designing an LTIP, companies need to be careful that their long-term incentive plan supports a sharp focus on performance and aligns executive behaviour with shareholder interests as well as consider other stakeholders’ perspectives.
 
The right long-term incentive plan for an organisation is one that drives executives to think long-term and balance short-term objectives against longer-term business goals. Achieving this requires thoughtful consideration and precision in the design process.
 
The LTI vehicle of choice throughout South East Asia has been stock options primarily due to their favourable accounting treatment in the past. With the adoption of IFRS2 and the convergence of accounting standards in jurisdictions around the region, the accounting treatment advantage which stock options had over other forms of long-term incentives is now non-existent. However, many companies continue to use stock options as a matter of legacy and chiefly because they have not been able to leverage the power  of long-term incentive effectively. Recently, we are hearing less than encouraging comments from business leaders in Singapore and throughout the region that their LTIP are failing to deliver on their two key objectives - to focus employee behaviour on the desired performance, and to assist in the retention of executives and other key employees.
 
Here are some typical comments we have heard:
 
  • “The LTIP is not cost-effective. Our expenses are more than the employee benefit received.”
  • “We are not sure how much our LTIP contributes to the retention of employees and/or motivating desired performance.”
  • “Our employees do not view our scheme as long-term – disposing of shares when they vest – rather than holding the shares and receiving dividend payments and enjoying future stock price appreciation.”
  • “Our shareholders are not happy with their ownership being diluted by the newly issued shares that are used to fund the long-term incentive plan.”
 
The subject of LTIP has always been complex. The design, or re-design, of an appropriate and effective LTIP involves the careful consideration of many questions, such as looking at the most appropriate vehicles, the right performance metrics, including the right people (and the right number of people) in the programme and whether the LTIP allows the company to maintain a competitive position.
 
Since 2006, Asian economies, including Singapore, are moving away from stock options towards performance shares, which are generally awarded only if certain company-wide performance criteria are met, such as total shareholder returns (TSR), return on equity (ROE) and earnings per share (EPS) targets. Indeed, TSR has become the most common metric in all markets in Asia except mainland China and South Korea. Towers Watson research also points to increased use of restricted shares, which are granted with time-based vesting conditions. The popularity of performance share and restricted share plans stems from the ability of such plans to motivate and reward performance, create ownership and limit dilution.
 
The choice of participants in the LTIP must also be carefully modelled based on the amount of equity available. Some companies, in trying to be inclusive, make the mistake of including too many people. This results in a limited number of shares being spread over a large number of people and the value of each award becomes too small to motivate or drive desired behavioural outcomes and an inefficient use of the company’s reward dollars.
 
And how long should the performance period be? Some argue it should be dependent on industry practice and business strategy. The most common arrangement in Singapore is three years. But some CEOs argue that it is difficult to set achievable goals for a multi-year period because their business environment changes too frequently. We think a performance period of between three to five years may be necessary to ensure participants do not take a short-sighted view and will be driven to work for the long-term growth of the organisation.

About the author
 
Kevin Ong is Towers Watson Director of Executive Compensation for Southeast Asia