Performance Targets - be careful what you wish for

Posted by RM2 at 15:14 on 6 Apr 2018

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Author: Nigel Mason

Performance targets are a common feature of share option awards, granted under plans such as the Enterprise Management Incentive Plan (EMI) but are they really necessary? That might be a controversial question, especially for companies in sectors with a strong culture of performance management like recruitment companies and estate agents and financial advisers. Such companies often ask for the exercise of options to be conditional on the employee’s achievement of some stretching personal targets, such as sales commissions or clients’ assets under contract.
But in my experience, it is very difficult to set performance targets fairly. Business is fraught with uncertainty and, in practice, performance targets often turn out to have been set too leniently or, more commonly, too harshly. As a result, the employee discounts the expected value of the option so deeply that the option award fails to become an incentive; it can become more of a constant reminder of failure and the unreasonable expectations of the employer – the opposite of the desired effect!
The same is true in listed companies, where the rapid escalation in executive pay has been blamed in part on share-based awards that are saddled with burdensome performance targets. In an attempt to reassure investors that executive incentives are aligned with shareholders’ interests, remuneration committees have layered on target after target, some of them - such as Total Shareholder Return (“TSR”) relative to a peer group – almost completely outside the control of the recipient, to the extent that the option feels to the employee more like a lottery ticket than a motivating incentive. Small wonder executives have demanded more and more share-based pay when the expected value after taking into account multiple performance targets is so low.
There is a simpler approach I would like to advocate. Instead of making the exercise of a given amount of options conditional on the future achievement of personal performance targets, why not make the initial employee share plan grant itself performance-related? In other words, set out what is expected of employees in the year ahead, and make the quantity of options they receive at the end of that year conditional on that year’s outcome. Then make the exercise of those options conditional only on the employee staying in employment for a fixed period (the classic “vesting period”) and also, for exit-based schemes, on the company achieving a change of control of some kind. That way, the options have far greater perceived value to the employee since they are no longer weighed down with additional hurdles. The employee who has received options is motivated by one thing and one thing only: the growth in the share value of the company, for which he or she has to stay loyal to the company until the exit date. Isn’t that really what the company wants: to reward proven performers and encourage them to stay?
RM2 can advise you on performance targets as part of the design and implementation of your EMI, Long term incentive plan (LTIP), Company Share Options plan (CSOP) or any other share option plan you may operate. We offer an initial phone call consultation free of charge. Contact us on 0208 949 5522 or email us at enquiries@rm2.co.uk if you would like to arrange a time to talk with one of our advisers.