Update on recent trends regarding Restricted Share Schemes
November 27, 2020
Our April newsletter included an article on restricted share schemes, in particular making reference to research from the Purposeful Company (published at the end of 2019) suggesting that a growing body of investors are willing to consider alternative remuneration structures (to the standard LTIP), if the Remuneration Committee can argue the strategic benefits of adopting such schemes.
The Investment Association even encouraged Remuneration Committees to consider whether a restricted share scheme may be more appropriate for the senior executives of their company than the existing LTIP – typically a performance share plan.
In September this year, the Purposeful Company published a “Progress Review” of restricted share schemes (it refers to them as “deferred shares”). In this Review, it states that: “New FTSE100 implementations of deferred shares to replace an LTIP include: BT Group; Burberry; Lloyds Banking Group and Whitbread. Nearly 1 in 10 companies in the FTSE 350 (excluding investment trusts) now use a deferred share model in place of LTIP in various configurations.”
It is interesting to observe however, that whilst the BT plan and the Burberry plan both received 95% votes in favour from their shareholders, Lloyds and Whitbread only received 64%/70% votes in favour.
Earlier this month the IA published its annual update to its Remuneration Principles and in its letter to Remuneration Committee Chairs it said: “A number of Remuneration Committees are considering if the use of restricted shares is more appropriate for their company in the current environment – especially given the difficulty of setting meaningful long-term performance conditions at this time. Whilst 2020 has seen shareholder approval of a number of new Restricted Share Schemes, shareholders will still consider the strategic rationale for the implementation of such schemes. This will continue to be a key driver for shareholders and the inability to set meaningful performance targets is not a reason in itself to move to a restricted share model.”
The letter went on to say: “As with other Long-Term Incentives, Restricted Share Scheme awards should consider whether the size of the grant is appropriate where share prices have fallen and would otherwise risk windfall gains on vesting. Where companies introduce a Restricted Share Scheme, the Remuneration Committee should consider share price factors in addition to the usual discount rate of at least 50% from the LTIP grant level that is expected by members to avoid awarding the same number of shares as would usually have been granted.”
In the Principles themselves, the IA has in effect set a pathway through which a new restricted share scheme will have to fit, it seems, before the IA will support it. There are five key issues that Remuneration Committees should consider (i.e. include in any new plan) before moving over to a scheme, of which three in particular need to be stressed. These are as follows:
- There should be a well explained strategic rationale for the introduction of such a scheme;
- There should be discretion and some form of underpin. The new scheme must give the Remuneration Committee the ability to exercise discretion on vesting outcomes. This will allow the Remuneration Committee to guard against payment for failure. There is also a suggestion that as far as some IA members are concerned, there should be a quantitative underpin (such as TSR performance above a hurdle) that needs to be achieved prior to any award vesting;
- Levels of awards should be at a discount to where they were under the company’s previous LTIP. [IA] Members believe that the discount rate for moving from an LTIP to restricted share awards should be at least 50% and grant levels should be held at this level and should not gradually increase over time.
Another issue that the IA believes needs to be carefully considered relates to the vesting periods that should attach to restricted share awards and the subsequent holding period. The IA states that the vesting period should be at least five years and preferably longer.
For most companies considering the introduction of a new restricted share scheme, a vesting period of five years should not be a problem. However, there are some investors who believe that the vesting period should be longer still, seven years plus, including after retirement. This may create a problem, as executives tend to discount the value of anything the receipt of which they perceive to be too far into the future.
As it happens, most restricted share schemes that have been adopted have five year vesting (and no more than that).
Perhaps the biggest problem that the IA has put up is this concept of an underpin. As the Purposeful Company’s recent report says: “The investor requirement for stringent underpins is a factor that creates a barrier for companies wanting to implement restricted shares as the existence of underpins means executives are not entirely trading ‘certainty’ for reduced quantum.” The key word here is “stringent”. We can understand why investors are looking for an underpin of some sort, but surely they should not expect it to be too tough. If they do, aren’t we just looking at another performance share plan albeit by another name and with more limited upside.
One of the concluding statements in The Progress Review is: “We are at an inflection point. If niche adoption is all that investors want, companies and their advisers now know how to secure shareholder and proxy agency approval to a standard template proposal [i.e. to follow the IA Principles on this matter]. On the other hand, if investors are receptive to alternate, more bespoke and potentially more radical constructs (which could arguably be better aligned with the company’s strategy and business needs) now is the time to enable a wider range of market practice to emerge.”
In effect, the IA’s alleged support for restricted share schemes has been tempered by the fact that, in reality, the IA will seemingly now only support such a scheme if it is just a dumbed-down performance share plan.
Unfortunately, it is also clear that remuneration committee chairs are for the most part being advised (by the IA and other investor bodies) that now is not the time to make radical changes to their remuneration policies anyway. This should, surely, be a matter for remuneration committees and their boards to decide.
Given that the IA has also stressed that an inability to set meaningful performance targets is not a reason in itself to move to a restricted share model, it seems likely that we will not see that many new restricted share schemes in the upcoming AGM season. That is not to say that they will not gain more support in the future but for now the IA’s stance seems likely to have put the brakes on the adoption of these schemes as a replacement for existing LTIPs. However, we remain of the view that they will still be appropriate in some cases, as part of a tailored total remuneration policy.