Listed company long-term executive share incentive plans

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1 Financial institutions Energy Infrastructure, mining and commodities Transport Technology and innovation Life sciences and healthcare Listed company long-term executive share incentive plans Incentivising your people

2 Incentivising your people This brochure is part of the Norton Rose Fulbright LLP Incentivising your people series which covers a range of equity and cash-based employee incentive schemes. For more information on other arrangements which may be appropriate for your business please contact Introduction We summarise below the main structures typically employed by companies listed on the London Stock Exchange Main Market for the purpose of delivering share incentives for executives and, in particular, outline: the different types of share plan available the principal terms and features common to listed company share plans institutional investor guidelines, investor expectations and market practice. Our intention is to provide a high level overview as a starting point to assist you in adopting a share plan portfolio which addresses your recruitment, retention and incentive objectives. Which type of share plan should you adopt? Two principal choices There are many different names given to share incentive arrangements: option schemes, restricted stock, restricted stock units, long-term incentive plans, deferred share bonus plans, nil-cost options etc. However, the principal choice is between a Share Option (an Option) and a Performance Share Award (a Performance Share Award): Share Option An Option is a right to acquire shares in the future at a fixed price, usually equal to the quoted market price when the Option is granted. Performance Share Award A Performance Share Award provides for free shares subject to performance conditions. A Performance Share Award will take the form of either a nil-cost option or a conditional award of shares which vests automatically. 02 Norton Rose Fulbright May 2014

3 What are the principal differences between an Option and a Performance Share Award? Over the last few years, listed companies have tended to provide directors share incentives through Performance Share Awards rather than Options. Many listed companies choose to grant Performance Share Awards subject to performance conditions to executive directors and Options subject only to service conditions to less senior executives. In any event, we recommend that prior to listing a company adopts a share plan which allows for both Options and Performance Share Awards so that the remuneration strategy may be operated flexibly. The main differences between Options and Performance Share Awards and the principal reasons why companies have favoured Performance Share Awards are set out below. Incentive value An Option which is underwater (i.e. the current share price is lower than the exercise price) holds little retention value and may even be disincentivising for the optionholder, particularly if, despite the share price, other performance criteria have nevertheless been met. Since Performance Share Awards are over free shares they will always hold some retention value regardless of share price movement. Shareholder alignment Some investors feel that the exercise price of an Option can overly focus the executive on achieving short term share price movements as opposed to focusing on long-term growth. On the other hand, it is argued that, since the value of a Performance Share Award relates directly to share price at any point in time, Performance Share Awards provide a better incentive to the executive to increase long-term share value. In addition, delivering shares through Performance Share Awards encourages longer-term share ownership, whereas executives will generally sell all their Option shares immediately following exercise in order to fund both their exercise price and tax charges. Dilution Options are very wasteful of shares and applicable dilution limits imposed by investors come under pressure more quickly if a company is delivering share benefits through Options. Since Performance Share Awards provide free shares, the same net benefit can be delivered to the executive using fewer shares than with an Option and Performance Share Awards are therefore a more efficient form of incentive in terms of overall share numbers and dilution. Accounting charges Accounting charges under International Financial Reporting Standard (IFRS) 2 Share-Based Payments can also reduce the relative attractiveness of Options compared to Performance Share Awards. In certain circumstances, a lower accounting charge can be achieved for the same benefit delivered to the executive by structuring the benefit through a Performance Share Award rather than through Options. Norton Rose Fulbright May

4 Design features We set out below a list of the main features you need to consider in adopting a share incentive plan and some guidance on market practice and institutional guidelines. The Association of British Insurers (the ABI) publish guidelines on best practice for listed company share incentives (known as the ABI Principles) and these should, if possible, be followed. You can view the guidelines at However, if you do not consider that it is appropriate in your circumstances to comply with the material recommendations of the ABI Principles such as the dilution, individual grant limits and change of control provisions (as summarised below), you must seek the advice of your financial sponsors on the impact on marketing your IPO and likely investor response going forward. Participation Only executive directors and employees should participate in a listed company s share incentive plans. The UK Corporate Governance Code (which must be adhered to by all listed companies on a comply or explain basis) states that non-executive directors should not participate in share incentive plans, in particular since participation would prevent them being deemed to be independent. It is, however, acceptable to investors for non-executives to receive a proportion of their fees in shares. Plan dilution limits Investors expect listed companies to keep within dilution limits restricting the number of new issue shares available under their share plans. The ABI Principles provide that the overall number of shares issued to settle awards under all share plans should not exceed ten per cent of the company s issued share capital over ten years. The ABI further recommend that of this ten per cent, a maximum of five per cent is used for share awards granted to directors and senior executives. Size of individual awards and annual grants Listed companies normally grant share awards (whether Options or Performance Share Awards) each year and as a matter of practice will operate a flow rate limit to ensure that they remain within their maximum ten year overall dilution limit. This is the approach recommended by the ABI. Investors expect share plans to specify individual annual maximum grant limits based on salary multiples. Broadly speaking, market practice is currently to apply a maximum limit of between 1-2 times an individual s salary for annual Performance Share Awards and 2-3 times salary for annual Options (the value of the shares being calculated at the date of grant of the award). It is normally acceptable to exceed the grant limit in exceptional circumstances such as an executive s recruitment. 04 Norton Rose Fulbright May 2014

5 Typically performance is measured over a three year period, which means that an annual grant policy results in annual vesting or exercise opportunities. This phased annual grant approach will maximise the retention value of your share plan. Performance conditions The remuneration committee will need to consider performance conditions and investors will pay close attention to conditions disclosed in the prospectus and in annual remuneration reports. The rules of the plan will provide your committee with wide discretion to adopt different performance conditions appropriate to the company s long-term business strategy and there is no requirement for shareholders to approve these conditions. Details of the performance conditions for the initial awards granted on listing or within the first year should be disclosed in the IPO prospectus and thereafter performance conditions applicable to directors awards must be set out in the company s annual remuneration report. Market practice in your sector is a key indicator of the conditions which are likely to be acceptable to investors. However, by way of general guidance on overall market practice: Investors will expect more demanding performance conditions to apply to Performance Share Awards because these comprise free shares. It may be acceptable to grant market value Options to more junior management without performance conditions and only subject to continuing service. Investors will always expect performance conditions to apply to directors awards and conditions should normally relate to overall company performance such as growth in income and/or share value. For example: the company s growth in earnings per share (EPS) over three years must exceed inflation by a target percentage (usually not less than nine per cent) and/or the company s growth in total shareholder return (TSR) is compared to TSR growth against an index or group of comparator companies with upper quartile performance triggering full vesting. It is typical for companies to adopt bi-furcated conditions, for example with 50 per cent of the shares subject to an award dependent on a TSR condition and 50 per cent dependent on an EPS condition with a range of targets set within each condition. Whilst EPS and TSR are conventional conditions they may not provide relevant measures for all companies. Deciding on performance conditions can be the most difficult element of the share plan design and, if the appropriate conditions are not obvious, you should seek specific advice from a remuneration consultant. Norton Rose Fulbright May

6 Service conditions and leavers Retention is an integral part of the incentive plan and if executives leave the company before the end of a specified vesting period (normally not less than three years), their share award should lapse. It is common for the position to be varied for good leavers who generally include executives whose employment is terminated involuntarily on account of death, injury, disability, redundancy or retirement. It is also typical to include a discretion to treat an executive as a good leaver in other circumstances the company deems appropriate. The ABI recommend that good leaver awards vest on a pro-rated basis (i.e. taking into account the period the executive has served as a proportion of the award s normal vesting period) and subject to any performance conditions. However, some companies simply reduce the award based on the foreshortened time period and waive the performance condition. Takeovers In the event that the company merges or is taken over following listing, the ABI Principles require that awards may vest early only on a pro-rated basis taking into account the foreshortened vesting period and the extent to which the performance conditions have been met. It is not always possible to assess the extent to which a performance condition has been met and in these circumstances it is normally acceptable for the remuneration committee to determine the extent to which they would deem it likely for the condition to have been met at the end of the normal performance period. The terms of the plan will also provide for the possibility of a roll-over of awards into shares of the acquiring company, which may be appropriate for executive retention. What next Please consider the choices described above, bearing in mind there is scope for deviating from market practice and the ABI Principles if there is a strong, justifiable commercial reason. We suggest that we work with you to produce a term sheet setting out the key features of the plan and awards you wish to grant in the foreseeable future which we can submit to your financial advisor for discussion. The Listing Rules provide that, subject to limited exceptions, share plans must be approved by shareholders. However, this does not apply to any plans adopted prior to listing and fully disclosed in the Admission Prospectus and it is usual therefore for any company making an initial public offer to adopt all its share plans immediately prior to listing. In addition to Listing Rule requirements, UK incorporated companies trading on the Main List are now required to seek shareholder approval for their remuneration strategy (including the principal terms of their long-term share incentive arrangements) every three years or earlier if there is a material change in strategy. 06 Norton Rose Fulbright May 2014

7 The UK Corporate Governance Code requires that the overall remuneration strategy together with the arrangements for individual executive directors must be approved by its remuneration committee, comprising independent non-executive directors and appointed as part of the IPO process. It is typical for remuneration committees to seek the advice of an independent remuneration consultant who, in addition to benchmarking services, will also be able to advise on detailed aspects of the share plans, including appropriate grant levels and performance conditions. Norton Rose Fulbright has good relationships with a number of independent consultants and we are happy to recommend specialist advisers in this field if required. Norton Rose Fulbright employee benefits and executive compensation team The Norton Rose Fulbright employee benefits and executive compensation team advises on all types of employee share schemes and cash bonus arrangements for listed and private companies operating in the UK and overseas. We are a dedicated incentives team providing wide-ranging advice on tax planning, company and employment law, corporate governance and best practice. We believe in building long-term relationships with our clients and their management teams with many of whom we have worked from their initial start-up through MBOs, sales and IPOs. We have particular knowledge in designing and implementing tax-efficient incentive structures suitable for private and small listed companies anticipating strong growth up to and beyond anticipated exit events. Contact If you would like further information please contact: Monique Fry Global head of employee benefits and executive compensation Norton Rose Fulbright LLP Tel Louise Dent Senior associate, London Norton Rose Fulbright LLP Tel Norton Rose Fulbright May

8 nortonrosefulbright.com Norton Rose Fulbright Norton Rose Fulbright is a global legal practice. We provide the world s pre-eminent corporations and financial institutions with a full business law service. We have more than 3800 lawyers based in over 50 cities across Europe, the United States, Canada, Latin America, Asia, Australia, Africa, the Middle East and Central Asia. Recognized for our industry focus, we are strong across all the key industry sectors: financial institutions; energy; infrastructure, mining and commodities; transport; technology and innovation; and life sciences and healthcare. Wherever we are, we operate in accordance with our global business principles of quality, unity and integrity. We aim to provide the highest possible standard of legal service in each of our offices and to maintain that level of quality at every point of contact. Norton Rose Fulbright LLP, Norton Rose Fulbright Australia, Norton Rose Fulbright Canada LLP, Norton Rose Fulbright South Africa (incorporated as Deneys Reitz Inc) and Fulbright & Jaworski LLP, each of which is a separate legal entity, are members ( the Norton Rose Fulbright members ) of Norton Rose Fulbright Verein, a Swiss Verein. Norton Rose Fulbright Verein helps coordinate the activities of the Norton Rose Fulbright members but does not itself provide legal services to clients. References to Norton Rose Fulbright, the law firm, and legal practice are to one or more of the Norton Rose Fulbright members or to one of their respective affiliates (together Norton Rose Fulbright entity/entities ). No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose Fulbright entity (whether or not such individual is described as a partner ) accepts or assumes responsibility, or has any liability, to any person in respect of this communication. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of the relevant Norton Rose Fulbright entity. The purpose of this communication is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose Fulbright entity on the points of law discussed. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your usual contact at Norton Rose Fulbright. Norton Rose Fulbright LLP NRF /14 (UK) Extracts may be copied provided their source is acknowledged.

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