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EXECUTIVE PAY – Why FDs’ pay is still optional.

The evidence is all there in the first ever Financial Director FTSE-100 executive share options survey: share options may be an increasingly unfashionable way of rewarding directors and other senior managers, but they’re not dead yet. In fact, in the last twelve months reported on by FTSE-100 companies, options with an exercise value of more than £22m were handed out to top-level FDs – and they’re already showing a profit of more than £3m (although they can’t be exercised for at least a couple more years). FDs exercised share options giving them the right to acquire shares for £4m in aggregate, then sell them for an £8m profit. And at the end of their respective financial years, FDs still had options to buy shares worth £92m, which were showing a profit of £62m over and above that. On the other hand, more than half of these FDs received no new share options, and a growing number of companies have decided not to replace lapsed executive share option schemes, preferring to go for other types of long-term incentive plans (LTips) – schemes that are generally less-highly geared on the upside and which present more challenging hurdles than most share option schemes do. The standard features of a share option scheme are: – They are typically awarded to senior executives who have corporate-wide responsibilities (not just directors); – The exercise price is that prevailing immediately before options are granted (so there is no artificially discounted exercise price); – They must be exercised between three and 10 years later, subject to: – A common threshold is that earnings per share must grow by an amount equal to the RPI + 6 percentage points over a three year period. Other conditions may be related to total shareholder returns (TSR) (typically relative to the FTSE-100 or a peer group of companies); Note that almost all have Sharesave options, for which they set aside up to £250 a month and receive options to buy shares at up to a 20% discount after three or five years – a not insignificant tax-break. The problem is that the common condition that eps must grow by a real 6 percentage points over three years is no more demanding than ensuring that growth at least matches that of real GDP. Newer LTips tend to have sliding scales based on relative performance – eg, nothing for bottom quartile performance, 25% of bonus for third quartile, etc – and tougher measures for maximum payout. But some companies have chosen to throw out just the bath water and not the baby. Billiton has structured a sliding scale formula so that only some – or even none at all – of the previously granted options can actually be exercised if the company’s TSR performance against 17 other mining companies isn’t good enough. Royal & SunAlliance says that “an effective share option scheme remains the most appropriate long-term incentive for the group”, although it recently announced a more targeted scheme. Railtrack is replacing an LTip with a “conventional” share option scheme. Rolls-Royce even says that it regards its lack of a current share option scheme as “a serious constraint on the ability of the company to offer competitive remuneration packages. This is particularly true in North America … where the concept of an LTip is neither well understood nor widely applied.” Indeed, it’s interesting that share option schemes became unfashionable here just as they started to become the rocket fuel that made Silicon Valley start-ups possible, turning twenty-somethings into e-millionaires. So expect FDs to keep their options open for a while longer.

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