There are various methods of rewarding executives and managers in Pakistan; out of these some are the LTI (Long Term Incentives) and some are the STI (Short Term Incentives). Options and shares are included in the LTI.
In shares executives are involved in the equity and they are rewarded with the issue of shares of the company to them instead of the cash rewards. In options executives have the write in future to have the shares at the price determined today instead of market price at that time, because option is a contract that gives the holder a right to buy the shares at some predetermined price within a specified period of time.
The only difference between the shares and options is that in shares you are rewarded with the equity (shares) but in options you have the choice (option) to buy the shares. In Pakistan options can have a legitimate role in executive remuneration as part of a properly designed LTI plan.
The issue in the current public debate of Pakistan is on the use of options; and then the issues are needed to be discussed like on the cost of options, disclosure, plan design quality and balance between corporate, shareholder and employee interests, etc.
It is very important that highly leveraged executive remuneration packages let the executives to act in their own interest even at the expense of shareholders and some other stakeholders of the company, and some times acting illegally.Options normally influence executive behavior - after all, if options don't influence behavior, it is hard to justify their use in executive remuneration.
LTI ELEMENTS AND OBJECTIVES: How to attract and retain top talent, reinforce performance, and pay for performance continue to be fundamental and challenging, 'people' questions for companies.
The level of performance that justifies a payment is, of course, a critical issue, and will vary by company and perhaps by industry sector. The basic elements of executive pay are fixed pay (basic salary plus benefits) and variable pay (i.e. annual/Short Term Incentives and Long Term Incentives).
The competitiveness of an executive's pay package is determined by considering the total value of fixed and variable pay - what we see in the market (Pakistani environment), not surprisingly, is that the proportion of fixed pay is higher where there are lower variable reward opportunities.
BROADLY, THE OBJECTIVES OF LTI PLANS ARE TO: * Better align the interests of executives and shareholders;
* Reward executives for delivering value to shareholders;
* Provide an attractive variable remuneration opportunity to executives contingent on achievement of performance hurdles; and
* Attract, motivate and retain executive talent.
Objectives of this type remain valid, and LTI plans remain an appropriate - and defensible - component of executive remuneration programmes. Shares and options are generally regarded as the best reward vehicles for achieving these objectives.
DESIGN ISSUES GO BEYOND CHOOSING WHETHER TO USE SHARES OR OPTIONS: Performance measures and the performance targets, in particular, must be set with a great deal of care to ensure that the LTI plan will achieve its objectives and provide reasonable and worthwhile rewards for the executives if, but only if, appropriate performance objectives have been satisfied.
Assessing company performance against that of an appropriate comparator group is also critical in order to avoid the provision of excessive rewards just because, for example, a bull market drives up the share price.
The substitution of performance shares for options, for example, will not make a great deal of difference if the rest of the LTI plan design makes it too easy for executives to earn significant rewards.
So - how many options or shares should be granted?
Options are an unpredictable reward and investment vehicle with no apparent or obvious immediate value at the time they are issued and an uncertain long-term value. To date, options have had no accounting cost.
These characteristics have prompted some companies to grant excessive quantities of options because they have incorrectly felt them to be cost- and risk-free. However, methodologies are available for putting a value on options for remuneration and accounting purposes. The remuneration value of options granted to executives in different companies can then be compared.
The speculative value of the LTI components of executive remuneration should generally be determined, via these methodologies, as a percentage of fixed-pay based on, and compared to, competitive market remuneration practices.
If shares were being offered, we would simply divide the rupee value of the LTI component by the share price at the offer date to determine the number of shares to be offered.
This number of shares would only vest in the executive if company performance is at the level that would justify the maximum reward under the LTI plan. Where performance is less than this, fewer shares would vest; no shares would vest if performance is below the threshold performance level.
There is no one, universally applicable, answer to the question of whether options or shares should be used as the vehicle for LTI plans. Every case should be considered and decided according to the available information and situation
Issues to consider include:
1. The fact that an executive can receive more options than shares for a given LTI value means that options have the potential to provide greater value to the executive than shares, at least where the share price increases significantly above the price at grant date.
2. In other circumstances, shares may have more value than options, because the executive is eligible to receive the underlying share value as well as any increase in that value.
The fact that an executive holding shares also suffers a loss of value if the share price falls has prompted some to argue that shares align more closely with shareholder interests than options, but this argument is misleading, for the reasons stated in the following point.
3. An executive holding shares suffers a decline in the reward delivered if the share price falls, but options are worthless (and not exercisable) if the share price falls below the exercise price (which is typically, but not always, the share price at the date the option was granted).
If LTI plan performance hurdles are not met, executives will not be able to exercise options even if the options are in the money. In these cases, performance shares also would not vest.
So it is suggested that a mix of options and shares be used in executive LTI plans because of the different characteristics they offer. A number of major foreign companies have adopted this approach.
Rawalpindi and Islamabad top 50 LTI analyses (2003/2004)
Incentive vehicle % Options & shares 8% Cash bonus 53 Options offering analyses % Companies offering 14% Companies not offering 86%
A survey was conducted in the twin cities to get feedback for this topic. Executives and CEOs of more then 50 national and multinational organizations were interviewed.
And the results showed that in Pakistan currently shares and options are not mainly used in the reward vehicle. Only 14 per cent of the organizations are using this reward vehicle and in these organizations shares and options are 8 per cent of the total annual reward.
PAY MUST VARY WITH PERFORMANCE: It is important to note that variable pay - or pay for performance - will only be effective if there is both the risk of lower pay and the potential for higher pay. The rewards must be consistent with both, the difficulty of achieving objectives and the value of those objectives to the company and shareholders.
In other words, to align pay with performance following points must be considered:
* COMPETITIVE PAY: Deliver competitive pay for competitive levels of performance.
* EXCEPTIONAL PAY: Deliver exceptional (i.e. above market) pay for high levels of performance;
* WITHHOLD PAY: Withhold pay for low levels of performance.
In summary, there is certainly a future for LTI equity plans that meet best practice standards. There is also a continuing role for options in best practice LTI plans.
Special in Pakistani economy because it is the best way to improve the output and performance of the organizations and the individuals. And all these practices will be seen in Pakistan in near future.