Performance Targets - be careful what you wish for
Posted by RM2 at 15:14 on 6 Apr 2018
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
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?