Share Incentives in a Market Downturn
Finding ways to incentivise employees can be difficult in the current economic climate. However, the use of share based awards such as growth shares, deferred payment arrangements or share options can be useful tools for motivating employees at a relatively low cost to an employer.
Arrangements can be tailored to suit the individual needs of your business and, when targeted at key individuals, can be used to encourage performance which will allow your business to ride the economic storm. Share based incentive arrangements are particularly useful as a motivating tool for employees and a tax efficient incentive when the current share price is low relative to the expected growth of a business in the next three to five years.
Key advantages of share based incentives in a downturn
- Cost efficiency – save for the initial outlay, there ought to be no significant running cost.
- Tax efficiency – if share values are low when arrangements are put in place, they are likely to be more tax efficient for both employees and employers.
- Options offer no risk for employees – employees can participate in the future growth of the business with no cash outlay until value can be realised.
- Utilisation of HM Revenue & Customs approved scheme limits – limits on the value of incentives which may be awarded under approved share schemes such as EMI will go further if share values are low.
Reviewing existing schemes
Employers should review how their existing share incentive arrangements are operating in the context of current market conditions.
For listed companies, the Association of British Insurers (the "ABI") advises that companies should regularly review share incentive schemes to ensure their continued effectiveness, compliance with the ABI guidelines and contribution to shareholder value. Although companies are not required to follow the guidelines, it is best practice to do so and to regularly review share incentive schemes.
Performance conditions in existing schemes may have become inappropriate or incapable of being met (particularly those related to share price performance). Underwater options (i.e. where the current market value of the underlying shares is less than the option price) also become an issue.
Underwater options
Employers may consider offering new incentives to employees in exchange for surrendering the underwater options or simply reducing the option price of the existing options. However, for listed companies this approach is considered by the ABI to be inappropriate and is likely to be unpopular with shareholders. Private companies are likely to have more flexibility in dealing with underwater options.
Care should be taken where EMI options have been granted, as the limits on grants include options which have been surrendered. This will affect the ability of the company to grant further tax efficient awards to employees going forward.
Performance conditions
Share based incentive arrangements often contain provision which allows a remuneration committee or board of directors to amend or waive performance conditions in certain situations. Again for listed companies the ABI Guidelines are in general critical of the retesting of performance conditions, which they state in their guidelines is unnecessary and unjustified.
Shareholder consultation
Private companies are likely to have more flexibility in relation to the amendment of awards and may choose to reduce an option price or waive or amend performance conditions. However, it is recommended that public companies consult their major institutional shareholders in relation to any proposed changes to existing arrangements. While shareholders may welcome new incentives which complement the current business goals and align employee incentives with an increase in shareholder value, they are unlikely to warm to a price reduction alone or a waiver of performance conditions given that they are not otherwise compensated for any fall in value of their own shares.
Redundancy
The impact of redundancies on share based awards should not be forgotten. Often redundancy is a 'good leaver' event within a scheme, allowing employees to exercise options (in some cases, regardless of whether performance conditions have been met) or resulting in share restrictions falling away. Furthermore, many private companies have leaver provisions within their Articles of Association which may require shares to be sold when an employee ceases employment.
Conclusion
The market downturn throws up both opportunities to establish new incentives as well as problems for existing schemes. If you would like to discuss any of the issues described above or any other share incentive issue, please contact:
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Karen Davidson |
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Christine Chalmers Senior Solicitor Corporate Tax Glasgow Tel. +44 (0)141 567 9482 christine.chalmers@mcgrigors.com |
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