16 October 2020
A significant number of companies are adopting restricted stock as an alternative to traditional executive remuneration structures, reports the Purposeful Company in their latest research.
The Purposeful Company Task Force have published a follow up to their October 2019 report on the use of ‘deferred shares’ in executive remuneration structures. The report identifies three categories of ‘deferred shares’ (often referred to in the market as ‘restricted stock’) being restricted shares, performance on grant plans and deferred bonuses. The 2019 report built on existing investor support for remuneration structures with greater flexibility and enjoyed much interest from companies, with many companies quoting it in their annual reports and acknowledging the benefits of restricted stock. The full 2019 report, its summary and our commentary on restricted stock can be found in our earlier alert here.
The new report provides a progress update on the implementation of restricted stock plans. We have summarised the key findings below.
- An increased number of companies have implemented restricted stock plans, with nearly 10% of FTSE 350 companies now adopting restricted stock. This is an increase from 5% observed in the 2019 report.
- Interest has increased in the US, with the Council of Institutional Investors advocating for the use for long-vesting restricted stock.
- There are concerns that companies and consultants are interpreting the Investment Association’s (IA) guidelines as a ‘standard template’ for shareholder approval, and only consider adopting restricted stock where this standard template works for them.
- The standard template follows these elements:
1. Restricted stock replaces LTIP entirely
2. Award quantum is reduced by 50%
3. The maximum timeframe of an award is 5 years
- Where companies have followed the IA guidelines on implementing a restricted stock plan, companies have generally enjoyed a 90%+ shareholder approval. However, the report comments that any deviation from the IA guidelines may result in a 30%+ vote against, which is contributing to companies favouring the standard template.
- Where companies do not follow the 50% discount in the level of award suggested by the IA, this seems to be a red-line issue for some investors and the ISS, who consequently make red top voting recommendations. However, not all investors take the same approach - Glass Lewis, for example, has not tended to red top companies based on the discount alone.
- As a result of this strict approach to design features, it is questionable whether the full benefits of a restricted stock plan are realised. For example, there is no increase on the normal “3 years + 2 years” LTIP approach which would support long-term value creation. Additionally the focus on discounted quantum arguably puts too much focus on the LTIP without considering broader remuneration package restructuring. If more flexibility is allowed it could create greater long-term alignment, for example by shifting part of the annual bonus (or even fixed pay) as well as LTIP into restricted stock.
Broader pay reform
- Proxy advisers can easily evaluate the standard template approach, however, this is discouraging companies from seeking alternative approaches which may contain bespoke design features.
- The Purposeful Company suggest that investors have a responsibility to guide proxy advisers if they wish to see broader pay reform they should:
- recognise that there may be a trade-off between the length of deferral and the discount;
- encourage deeper reform of pay going beyond just replacing the LTIP with restricted stock; and
- consider new approaches that address the concerns from some market participants that restricted shares result in too little pay variability.
- The ultimate responsibility remains with companies to persuade shareholders as to what the most suitable plans are for their businesses.
- COVID-19 has heightened interest in restricted stock, with existing structures showing their flaws in the crisis. In particular, the struggle to set meaningful and stretch incentive targets in a period of uncertainty, and addressing retention concerns when LTIPs are unlikely to vest.
- Business uncertainty combined with societal concerns are likely to result in a downward trend in LTIP pay-out levels in the coming years. This could make restricted stock more attractive in the future by making the discount rates appear less penal.
As part of Tapestry’s annual FTSE 100 review, we carried out a detailed review of the adoption of the restricted stock models referred to in the Purposeful Company’s 2019 report. We identified the same trend as reported in the updated Purposeful Company report - that 10% of the FTSE 100 companies have adopted restricted stock plans, and that those who have done so in 2020 have typically followed the IA’s guidelines. Despite the rigidity of this approach some companies adopting restricted stock have been able to tailor the mechanics of their plans to some degree.
We have seen those companies successfully implementing a restricted stock plan have done so after a period of constructive dialogue between the investors and the company. Which supports the Purposeful Company’s findings. This highlights the need to plan ahead and involve stakeholders early.
Following the successful adoption of a restricted stock plan by household companies such as BT and Burberry coupled with the uncertain impact of COVID-19, we expect that more companies will be considering restricted stock as an alternative remuneration structure. With many companies due to take their remuneration policies back to shareholders in 2021 and some choosing to go early, we expect that there will be more restricted stock plans emerging in the coming years.
A breakdown of the structure and commentary on each restricted stock plan used by FTSE 100 can be found in our reports. If you would like a copy please get in touch.
Carla and Sarah