Case Study: Promote Partnership with Long-term Incentives

Background
  • A large scale listed company in the FMCG industry has over 400 stores in Greater China. The company was experiencing slumping profit due to rising cost, tougher competition and slowdown of the Chinese economy, thus its stock price was at all time low. The CEO wanted to transform the company by adopting new business model and promoting partnership mindset among employees.
  • The company used to adopt a stock option plan and an annual bonus but they were not effective in incentivizing senior executives and loyal staff in turning around the business.
Objectives
  • Foster partnership mindset and increase alignment of interest among senior management through meaningful ownership.
  • Enable future leaders to become owners of the company, motivating employees to build and run the company as if their own company so they can share company success.
  • Provide potential upside for awardees in reaching upper quartile in total compensation due to potential appreciation in share price.
  • Balance between potential share dilution and cash flow issue.
The key project stages were to:
  • Discuss market practice and highlight key features that should be noted or avoided.
  • Thoroughly discuss the factors affecting the overall design with the CEO and project team. These include how to increase sense of employee’s participation, impact of different long-term incentives (LTI) vehicles on share price, P&L, disclosure requirements according to listing rules, effect on compensation competitiveness and employee perception.
  • Conduct LTI mapping for different categories of staff such as senior management, business heads, new business directors and functional heads.
  • Designed the key features to increase sense of ownership and promote partnership mindset.
  • Recommend strategies to fund part of the LTI from annual bonus and overcome resistance on stock based ownership among middle management.
  • Conduct 10-year projection and scenario analyses to ensure stock ownership is substantial to promote partnership but will not be excessive in the future.
  • Define forfeiture provisions to define the treatment of stock award for good leavers and bad leavers.
  • Provide implementation considerations to facilitate roll-out of the plan.
Results
  • The design was approved by the Board and the Remuneration Committee and became part of the transformation journey.
  • The revamped long-term incentive plan was launched 2 years ago, profit was up by 86% and share price was up by 38% since the implementation.
Illustration: ​Proposed Overall LTI Framework
Illustration: KPIs and Payout Range 
  • As KPI achievement will affect the final number of options to be vested, it is important to identify the relevant KPIs, set the relative weighting and appropriate targets at the beginning of each tranche.  
  • After the KPIs are identified, three levels of performance (i.e. threshold, target and extraordinary) for each KPI will be set at the beginning of each tranche. The KPI achievement will determine the final vesting of share options at each tranche (the data is made up for illustration only): 

​Illustration: Effect on Performance Contingent Stock Options -  When KPI Meets Target​
  • Assume stock price changes over the next few years as follows (the data is made up for illustration only):

​Illustration: Profit Sharing
  • The target bonus percentage is derived from cross referencing market pay levels and internal relativities in contributing to P&L.
  • Different bonus considerations:
    • Pre-tax profit sharing
    • Sharing of profit after depreciation
    • Turnover from new stores
  • Example: Employee A’s incentive is based on pre-tax profit growth (data is made up for illustration only)

​Illustration: Deferral Arrangement
  • For the LTI plan, if the annual total incentive exceeds 30% of the annual fixed pay, 60% of the incremental amount would be deferred as restricted shares and subject to 3-year cliff vesting (the data is made up for illustration only).
  • After the total incentive is determined each year based on the respective incentive calculation formula, the deferred amount will be converted to restricted shares based on the prevailing market price at the point of conversion. 
  • The long-term incentives (LTI) would be subject to 3-year cliff vesting and required good performance during the vesting period. Employees would receive the LTI in shares and the nominal value will be based on the actual share price at the time of vesting.

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