Share awards, or LTIPs, are used by almost all FTSE firms. You can use them too
As the economy starts to grow, retaining your key staff will be the next headache for management teams. However, there is an effective way to hold on to talented staff.
Share awards are a popular way of retaining talent and are, in essence very simple. Staff are awarded free shares in the firm, but with three conditions.
First, they can’t touch the shares for a stated period, usually three to five years. And second, the firm must hit certain targets, such as earnings per share, total shareholder return or another financial metric.
And, third, the staff member must stay with the firm.
The logic runs that the employee will be so keen to have the shares that they will pledge long-term loyalty and dedication to the business.
There are a couple of perks too for the firm. Awarding the shares costs nothing to the firm; they merely dilute the holdings of existing shareholders, who in turn get value back through better executive performance.
And there are tax advantages, created by the government to encourage entrepreneurship. These tax breaks are endorsed and approved by HMRC, so you won’t get challenged on them.
So what’s not to like?!
In fact, share awards, known as Long Term Incentive Plans (LTIP), are indeed vital to ambitious firms. But there are a few things worth knowing before embarking on a LTIP scheme.
Let’s start with the issue of vesting.
Before the recession, share options were common. These offered employees the right to buy shares at a certain price at a time in the future. If the share price soars during that time, the option can be valuable. But when share prices nose-dived, these options often became less valuable. What was supposed to be an incentive became a reminder of the problems facing the firm.
Share options present another tricky issue. Share prices can be talked up by a board. All it takes is a bit of loose talk and the rumour mill kicks into action…a share rally can be triggered. Share options can sometimes incentivise this behaviour. The last thing you want is the CEO and FD trying to ramp up the share price so their options vest.
Share awards avoid these difficulties. But they have their own issues. Performance goals mean shares only vest when targets are hit. But what if they are not? Staff may become disgruntled. It is possible they had already earmarked the money for a new kitchen or car. How will they take the bad news? It may not even be their fault the target wasn’t hit: market conditions may affect LTIP share awards just as much as share options.
There’s also the question of motivation.
How hard do employees really work when LTIPs are included in the remuneration package?
The truth is that evidence on the effectiveness of LTIPs is hard to find. It’s just so hard to collect data for a study. How can you isolate the contribution of an employee in a firm, and prove that it was the LTIP which encouraged them to go the extra mile? Not easy.
There is evidence that some employees get used to LTIP payments. They see it as part of their normal remuneration package, not as a generous extra. This mindset may diminish the value of an LTIP, particularly when awards are made each year, so the staff member vests shares each year as they mature.
LTIPs are also no guarantee of loyalty. The truth is that when a rival firm wishes to recruit a senior member of your staff they will just write out a cheque to cover the financial impact to that person. In the financial services industry this is routine. All an LTIP will do is make it more expensive for a rival to hire your top staff.
With all the tax and cash-flow advantages of an LTIP I get frequently asked why some firms still shun them.
Worries about share dilution are the biggest reason. At family firms in particular, there can be a mindset that allowing non-family members to accrue shares is a mistake. In reality this isn’t going to happen. Staff shares can be recycled when they leave: the firm buys them back, and trade to an external party is forbidden. But the perception is so strong that the family firm may decide against an LTIP.
International firms may hit difficulties too. Every country has differing securities laws. So it may not be practical to give a staff member in for example Russia or Colombia shares. It is easier to pay cash.
Employees may be tricky to convince. Sometimes they just don’t understand an LTIP and don’t want to learn. Perhaps they value cash now, rather than later. In these cases paying cash up front is preferable.
Since LTIPs are becoming a fact of life not just for FTSE and AIM businesses, but also for many unlisted enterprises, it’s worth knowing how to create the perfect LTIP package. Should the maturity period be three or five years? What performance metrics are best? How big should the remuneration package be?
The answer is that each business is different. Your long term aims, your attitude to staff retention etc, will all influence the way your LTIP is put together.
But rest assured – when it comes to attracting, and keeping, staff of the very highest calibre there are few better ways than an LTIP.
Vanessa Cundy-Cooper is a specialist at designing and implementing incentive plans and share plans at KPMG