Boardroom hunt for new executive virility symbol: Jane Simms looks at alternatives to share option schemes

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The Independent Online
IN A FEW days, Wellcome will allocate shares to its directors. The shares will be held in trust and then awarded to participants after three years in return for a proportion of their bonus, provided growth targets for earnings have been met. Wellcome plans to extend the scheme to other executives later.

The company has a variety of share schemes for employees of all levels, including an executive option scheme whose fate is undecided after it expires in 1995.

Neville Machin, group employee relations manager, explains: 'We are always looking for a balance, and for flexibility, in the way we reward and motivate people. But we feel that the higher the job level, the greater the risk to the business of the decisions those people make, so the bigger the reward we should make for the right decisions.'

The company felt it should be placing a stronger emphasis on more durable incentives. It dismissed a long-term cash plan in favour of the restricted stock scheme as an opportunity to align directors' and shareholders' interests. Wellcome is one of many companies seeking new ways to reward and motivate senior management. Share option schemes, the most popular method over the past decade, have become a thorn in shareholders' flesh and executives are also taking a more jaundiced view of a perk once considered attractive.

Consequently, companies are thinking long and hard about what to do later this year when many of the schemes put in place 10 years ago come up for renewal.

The argument that share options are a vital component of executive remuneration because they link directors' and shareholders' interests has been largely discredited. Because they are, in effect, free, they have been regarded as a perk and the performance element has been largely ignored.

The share price need only drift up with inflation and executives are in profit without having lifted a finger. Moreover, most sell their shares soon after they have exercised their options - allowed after three years. This undermines their value as a long-term incentive and a means of creating executive shareholders.

And executives have come to realise share options are a lottery: how much money they make on exercise depends as much on the day the options were granted as on the performance of either company or individual.

Notwithstanding proposed accounting changes that will put share options on the balance sheet, they are so embedded in the corporate psyche that they are unlikely to be scrapped. Like the company car or private healthcare plan, they have come to be regarded as executive virility symbols.

Indeed, the signs are that most companies will renew existing schemes. But the new plans will include performance criteria, such as growth in earnings per share, relative share price, or 'total shareholder return' - a combination of capital growth and dividends.

Guidance last summer from the two big shareholder groups - the Association of British Insurers and the National Association of Pension Funds - switched the onus on to individual remuneration committees to decide appropriate performance criteria, with the proviso that the exercising of options be linked to 'sustained underlying financial performance'. And, rather than granting options in one big chunk, companies are beginning to 'drip-feed' them. This not only spreads the risk for the executive but acts as a more durable incentive.

Yet even with such safeguards, share option schemes may still reward managers on the general strength of the market rather than individual company performance. Moreover, accounting yardsticks such as return on assets may be open to manipulation.

These shortcomings spurred Reuters to scrap its share options in favour of a restricted stock scheme earlier this year. Executives are awarded restricted shares at the beginning of the performance period. These are released five years later subject to performance, which is measured by comparing the cash return to a shareholder, including dividends, from investing in Reuters with that available from other FT-SE 100 companies.

No shares are granted if Reuters is ranked in the last 25 companies; all are released if it is in the top 40, with a graduated release between these points. The arrangement covers 17 executives.

The Prudential has operated a similar scheme since 1992, as well as its option plan. But the company awards a free share for every share an executive buys, and there are no performance criteria.

Boston Consulting Group, which helped develop Reuters' scheme, calculated that the company would have hit its top target in five of the past six years. Reuters has outperformed the FT-SE 100 by nearly 300 per cent since its flotation in 1984. But how motivated will executives feel when that rate of growth inevitably slows?

Carol Arrowsmith, managing director of New Bridge Street Consultants, admits the difficulty of striking the right balance with achievable but demanding targets. It is easy with hindsight to say targets were too soft, she says, but many companies have had unrealised share options over the past few years because performance criteria were not met.

The advantage of restricted stock schemes is that they are less volatile than share options. But that is a potential problem, according to Ron Amy, group compensation director at Grand Metropolitan and chairman of the NAPF. In the US, he says, companies with executives who have not benefited from share options have moved towards restricted stock plans. 'Rewards are more reliable and less risky, which suggests the need for more stringent performance criteria.'

Ultimately, all incentive schemes are little more than an act of faith. It is impossible to ascribe any rise in shareholder value to bigger rewards for executives. Their real value may lie in attracting and keeping top-flight executives.

Mr Amy agrees that 'to a large extent executive compensation is market-driven'. As that market becomes more international, companies must adapt their approach.

NFC bears out the theory. A long-term and vigorous exponent of all-employee share ownership, the transport company introduced an executive share option scheme in January.

Jeremy Letchford, company secretary, says: 'We felt we were out of line with the market in not offering executive share options.'

Perhaps share options are not that different from the company Jag after all.

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