Module 1: Introduction to Share Plans

Question 1

What are employee share plans?

Answer 1

Employee share plans (or share schemes) are arrangements enabling employees to acquire shares in their employing company, its parents or another group company.

Question 2

What are the two key types of share awards?

Answer 2

1. Right to acquire shares (employee has an award which gives them the right to acquire shares, in the future SUBJECT TO VARIOUS CONDITIONS (conditional)
2. Actual shares (employee acquires shares at the outset or upfront.
   Awards may be granted which will only deliver a cash payment, which may be linked to share value.

Question 3

Key characteristics of Conditional Share Awards or Restricted Stock Units (RSUs)

(Also free shares, restricted share/stock units)

Answer 3

. Employees are granted a conditional right to receive shares at A POINT IN THE FUTURE

. Usually do not pay for them or the right to receive them.
. Award is usually subject to conditions such as continued employment, performance based conditions, or time based conditions (i.e. 3 years).

. Used more so in discretionary plans, and NOT normally eligible for tax benefits.

. Shares are normally delivered to automatically to participants on vesting.

Question 4

Key characteristics of Options

Answer 4

. An option is a conditional right to acquire shares in the future.

. Employees must exercise the right to acquire the shares.

. Exercise price is set at grant (sometimes option price or strike price), that employees are required to pay to exercise the option and receive the shares.

. Exercise price can be
i. market value at the time of grant
ii. a discounted exercise price
iii) a nominal exercise price (only nom value is payable)
iv) nil cost - nothing is payable and the shares are acquired for free.

. The option is usually subject to conditions such as continued employment, performance based conditions, or time based conditions (i.e. 3 years).

. Employee usually chooses when to exercise.

. Can be used in discretionary and all employee. Tax benefits if granted under CSOP or EMI (disc) or SAYE (all emp)

Question 5

Key characteristics of Restricted Stock/Upfront free shares

Answer 5

. The employee owns the shares from the beginning. May be entitled to dividends and potentially vote.

. Usually subject to some conditions for a period of time and may be subject to forfeiture conditions.

Question 6

Key characteristics of Phantom Awards

Answer 6

. Employees are granted a right to receive a cash amount which is calculated accordingly to an underlying share value. May simply be called ‘cash awards’.

. Usually no special tax benefits.

Question 7

Do cash awards have any link to share value?

Answer 7

No - if there was a link this would usually be phantom or notional share awards.

Question 8

What is a SAR (Share Appriciation Rights)?

Answer 8

SARs give employees the right to receive a value equal to the difference between the market value of the shares at the time of exercise and the time of grant (this growth shares).

. Typically don’t have tax benefits.

. The gain may be settled in cash or shares.

Question 9

Who usually decides who may participate in a discretionary plan?

Answer 9

The Remuneration Committee (Remco).

Usually, all employees are elegible but only some (such as execs) can participate.

Question 10

Name some different types of share plans

Answer 10

. LTIP - sometimes called Performance Share Plans (PSPs)

. DBP

. Employee Share/Stock purchase plans.

. Share match plans

.Co-investment plan (or executive matching schemes)

Question 11

Key characteristics of an LTIP

Answer 11

. Employees receive shares in their employing company, or its parent, usally free of charge as part of their variable remuneration package (think of the slide showing a CEOs total package, part salary, part LTIP etc)

. Usually discretionary.

. Normally subject to performance conditions and subject to continuing employment. Awards will usually lapse if the employee leaves (may be exceptions for Good Leavers).

Question 12

Key characteristics of a DBP

Answer 12

. Sometimes call ‘share bonus’ or ‘DBSP’

.Employees receive shares in their employing company, or its parent, free of charge. Usually granted instead of the employee receiving some some or all of an annual bonus in cash.

. Usually discretionary and leave provisions are often more relaxed than LTIP.

Question 13

Key characteristics of an Employee Purchase Plan

Answer 13

”. These are plans which involve the participant purchasing shares in their employer (or its parent), usually using salary deductions.

. The shares are usually then purchased at a discount.

. In the US this is a US Employee Stock Purchase Plan (ESPP) aka Section 423 plans, which are tax favoured in the US.

. Frequently used for all-employee arrangements.”

Question 14

Key characteristics of Share Match Plans

Answer 14

. Same as a normal purchase plan, except for being issued at a discount, employers grant a matching shares, free of charge.

. Sometimes conditional so the matching shares ONLY, have conditions attached to them.

. Common in UK SIPs.

Question 15

Interesting Reading only - Why do companies use share plans?

Answer 15

Each company will have its own reasons for operating share plans. A share plan will always be more effective if there is a clear understanding of why it was introduced and why it is currently being offered (it is possible for the reasons to change over time).

Governments have in the past focussed on and shown support for employee share plans, considering them to be a key tool for driving an entrepreneurial culture in the UK which is vital to the economy.

A report produced by Proshare states evidence suggests employee share ownership could play a role in tackling the UK’s productivity crisis, improving economic growth, innovation and outcomes for employees such as higher
wages. Share plans could also be an important tool for bolstering the financial resistance of UK households.

Question 16

Key reasons why companies use share plans?

Answer 16

. Incentivise and Increase Productivity (link between better performance and reward, employees feel they can make contribution)

. Drive Innovation (owning part of the business and sharing in its success can encourage opportunities and innovation)

. Encourage Engagement and Commitment (gives employees a long term interest in the company’s performance, not just short term like next pay rise. May also be able to vote, holding may be very small, but still feel part of the company decision making).

. Reward (can provide employees with substantial remuneration and can also provide favourable tax treatment).

. Cash flow (granting shares can be cheaper for companies in cash terms then paying cash bonuses or increased salaries).
. Retention (usually paid out if stay for specified period (vesting))

. Recruitment (attractive, gives competitive advantage).

. Wealth sharing (enjoy the company’s value growth).

. Regulatory compliance

. Loyalty (i.e. if a company IPOs, may reward employees for seeing the transaction through).

Question 17

Give a reason why senior executives remuneration in the
financial services sector must be delivered in shares or other securities.

Answer 17

To encourage company leadership to seek long-term stability and success over short-term gains.

Question 18

Are listed companies free to design and adopt whatever type of plan they think will be right for them?

Answer 18

No - There are many constraints in practice due to the regulatory environment in which share plans operate.

Question 19

What is corporate governance?

Answer 19

Corporate governance = how a company governs itself.

Good corporate governance covers all aspects of how decisions are made, who
makes them, what is disclosed to stakeholders and the influence those stakeholders have.

Question 20

Who published and maintains the UK Corporate Governance Code?

Answer 20

The FRC (Financial Reporting Council)

Question 21

What was the first Corporate Governance Code called when published in 1992?

Answer 21

The Cadbury Report

Question 22

Who is caught by the UK Corporate Governance Code?

Answer 22

All companies with a premium listing on the London Stock Exchange.

The code primarily impacts remuneration for executive
directors.

Question 23

Must companies caught by the UK Corporate Governance Code, COMPLY with them?

Answer 23

No - it is a ‘comply or explain’ approach. If they do not comply, they must be able to explain why not, to ensure that
companies have the flexibility to adapt their arrangements to their own circumstances.

Question 24

Does the UK Corporate Governance Code OBLIGE companies to provide equity to employees?

Answer 24

No!

There are Code Provisions
relating to share awards but no strict requirements to grant these.

Question 25

The UK Corporate Governance Code is split out into Principles and Provisions.

Provide 3 Principles:

Answer 25

. Remuneration policies and practices should promote long-term sustainable success, executive remuneration should align to the company’s purpose and values and be linked
to the long-term strategy;

• there should be a formal and transparent procedure for developing policy on executive
  remuneration and for fixing the remuneration packages of individual directors and senior
  management, no director should be involved in deciding their own remuneration; and
• directors should exercise independent judgement and discretion when authorising
  remuneration outcomes, taking account of company and individual performance, and
  wider circumstances.

Question 26

Under what section of the UK Corporate Governance Code covers employee share plans?

Answer 26

Remuneration.

Other sections include:
- Board Leadership
and Company Purpose;

• Division of Responsibilities;
• Composition, Succession and Evaluation;
• Audit, Risk and Internal Control;

Question 27

The Corporate Governance Code sets out that the Principles should be supported by ‘high quality reporting on the Provisions…on a “comply or explain” basis’.

Name some of the Provisions:

Answer 27

• The RemCo should determine the policy for chair, executive director and senior management remuneration and should consider workforce remuneration and the alignment of incentives and rewards with culture.
• Remuneration schemes should promote long-term shareholdings by executive directors that align with long-term shareholder interests. Share awards for this purpose should be released for sale on a phased basis and be subject to a total vesting and holding period
  of five years or more.
• The Remco should develop a formal policy for post-employment shareholding requirements, encompassing both unvested and vested shares.

Question 28

Name some examples of Institutional Investors

Answer 28

Insurance companies, pension funds, trade unions and religious organisations.

Question 29

Who maintains the Principles of Remuneration?

Answer 29

The Investment Association

Question 30

Discuss some key points relating to The Investment Association (or ‘IA’).

Who do they represent and what is the purpose of their Principles of Remuneration?

Answer 30

• An organisation that represents 250 UK investment managers (all
  who invest in British companies), making them one of the most prominent institutional investor voices in the UK.
• The ‘Principles of Remuneration’ set out their
  members’ views on the role of shareholders and directors remuneration and how it should be determined and structured.
• The IA’s concern in relation to share incentives has historically been two-fold:

. the dilutive effect of companies issuing shares under their various share plans on its members’ shareholding interests in listed companies over a period of time;

and

. levels and structure of remuneration specifically for executives.

Question 31

What are the three areas the IA’s member expectations in relation to executive remuneration are broken down into?

Answer 31

• General guidance.
• Variable Remuneration.
• Fixed Remuneration.

Employee share plans are discussed in ‘GENERAL GUIDANCE and FIXED REMUNERATION’.

Question 32

The IA’s Principles of Remuneration relate to executive pay and long-term incentives for UK listed companies.

One of the main restrictions set out in the IA guidelines is in relation to limits on the
percentage of share capital that can be used at any time under share incentive plans. What are some other restrictions?

Answer 32

• Grant should only be made within the 42 day period immediately following the end of the closed period under the Market Abuse Regulation – generally the announcement of results;
• Options should not be granted at a discount (i.e., less than market value);
• Vesting of awards should be conditional on challenging performance conditions;
• Shares and options should not vest or be exercisable earlier than three years after grant;
• The combination of the performance period and holding period must cover at least 5 years with the performance period being at least 3 years out of those 5;
• Options should not be exercisable more than 10 years after grant;

Question 33

Are the IA’s Principles of Remuneration legally binding?

Answer 33

No - but companies pay close attention to them as the IA
highlights breaches of the guidelines to their members.

Question 34

IMPORTANT UNDERSTANDING

Code vs IA Principles of Rem

Answer 34

• The UK Corporate Governance Code predominantly influences executive director remuneration.
• Whilst the IA Principles also focus in many cases on executive remuneration, there are various elements to the IA Principles that influence share
  plan design more generally in the UK for main market listed companies.

Remember - Other institutional investor organisations (like PLSA and PIRC) as well as institutional investors themselves, such as Fidelity, Hermes, Blackrock and Aviva Investors all issue their own guidelines. Companies will typically look to adhere to the guidelines of institutional investors that have a large
shareholding in their own business.

Question 35

What are the four types of tax advantaged employee share plan in the UK?

Answer 35

Discretionary plans:
- Company Share Option Plan (CSOP) (providing for tax advantaged market value share
options up to a limit of £60,000, subject to certain conditions being met)

• Enterprise Management Incentive (EMI) (providing for tax advantaged share options up to
  an individual limit of £250,000 and company limit of £3M, subject to certain conditions. Rare for listed companies given the limits).

All employee:
- Sharesave or Save As You Earn (SAYE) (providing for tax advantaged share options, linked to a savings contract into which participants make monthly contributions from salary;

• Share Incentive Plan (SIP) – (providing for the purchase of shares out of pre-tax salary, awards of matching shares and/or awards of free shares)

Question 36

Key terms used in an LTIP are….

Answer 36

• Eligible employees (eligibility and participation are different)
• Grant of an award (This is the moment in time that the participant is given a contractual right)
• Vesting and vesting period: When the right ‘vests’ then, in the case of conditional share awards, the employee typically becomes unconditionally entitled to receive the shares.
• Conditions
• Lapse
• Settlement - the act of satisfying an award (i.e., delivering the shares to the
  participant).

Question 37

Key plan documents for an LTIP include….

Answer 37

• Plan rules
• Shareholder circular (if shareholder approval is needed to establish the plan)
• Deed of grant
• Grant/award document
• Covering letter
• Acceptance terms
• Explanatory brochure

Question 38

TEST YOURSELF:

1. Explain how share plans can incentivise employees to increase their productivity for a company.

Answer 38

A commonly cited reason for introducing employee share plans is that they provide an incentive for employees to do better/work harder for the company - i.e., be more productive. The value of what employees receive (shares) is intrinsically linked to the value of the business – thus encouraging employees to work harder, in order to receive shares worth a higher value.

Employees can feel that they can make a real contribution towards the success of the business in which they work. They are ‘partners’ in the business.

Question 39

TEST YOURSELF:

2. Why might a company choose to use shares rather than cash?

Answer 39

Can be cheaper for company;
preserves cash for company in economic uncertain times (e.g., as with COVID-19);
can be substantial reward for employee;
capital growth;
dividend income;
corporate and brand identity;
stake in ownership;
align interests with shareholders.

Question 40

TEST YOURSELF:

3. What is the key difference between conditional share awards and nil-cost options?

Answer 40

A conditional right to receive shares at a point in the future. Generally employees do not pay to receive them.

Like a conditional share award, an option is a conditional right to acquire shares in the future. However, employees must ‘exercise’ the right to acquire the shares under an option. This is different to conditional share awards, where the shares are normally delivered automatically to participants on vesting.

Question 41

TEST YOURSELF:

4. What is a SAR?

Answer 41

Share Appreciation Rights (or stock appreciation rights) – the right to receive a value equal to the difference between the market value of the shares subject to the SAR, calculated at the time of exercise, and the market value of the shares at the time the SAR was granted. In other words SARs are a right to the increase in value of a share/shares between grant and exercise of the SAR.

Question 42

TEST YOURSELF:

5. Do companies have to comply with the UK Corporate Governance Code?

Answer 42

In summary – a company subject to the Code (i.e., with a premium listing on the LSE) has to comply or explain why they are not complying (‘comply or explain’ approach).

All companies with a premium listing on the London Stock Exchange, whether incorporated in the UK or elsewhere, are required under the Listing Rules to report on how they have applied the Code in their annual report and accounts. A UK-incorporated company which is listed with a premium listing of equity shares on the London
Stock Exchange must include a disclosure statement setting out whether or not it has complied with the Code during the year in its annual report. If it has not complied, it must explain why not.

So, compliance with the Code is not obligatory and there are no penalties for not complying – as long as the non-compliance is disclosed and explained.

Question 43

TEST YOURSELF:

6. What should be the combined vesting and holding period for awards to executive directors under the UK
   Corporate Governance Code?

Answer 43

Remuneration schemes should promote long-term shareholdings by executive directors that align with long-term shareholder interests. Share awards for this purpose should be released for sale on a phased basis and be subject to a total vesting and holding period of five years or more.

Question 44

TEST YOURSELF:

7. Can you think of any other Principles or Provisions of the Code that influence executive directors’ remuneration?

Answer 44

Principles:
* remuneration policies and practices should promote long-term sustainable success, executive remuneration should align to the company’s purpose and values and be linked to the long-term strategy;

• there should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors and senior management, no director should be involved in deciding their own remuneration; and
• directors should exercise independent judgement and discretion when authorising remuneration outcomes, taking account of company and individual performance, and wider circumstances.

Provisions:
* The remuneration committee should determine the policy for executive director remuneration, as well as setting remuneration for the chair, executive directors and senior management and should consider workforce remuneration and the alignment of incentives and rewards with culture.

• Remuneration schemes should promote long-term shareholdings by executive directors that align with long-term shareholder interests. Share awards for this purpose should be released for sale on a phased basis and be subject to a total vesting and holding period of five years or more.
• The remuneration committee should develop a formal policy for post-employment shareholding requirements encompassing both unvested and vested shares.

Question 45

TEST YOURSELF:

8. What is meant by eligibility under an LTIP? Is this the same as who receives awards?

Answer 45

These are the employees who may participate in the plan and who may be granted awards under the plan rules. Eligibility is usually drafted very broadly, even in discretionary plans.

Remember: eligibility and participation are different. Eligibility is about who may participate, whereas participation is about who actually participates.

Question 46

TEST YOURSELF:

9. Are the IA Principles of Remuneration legally enforceable?

Answer 46

The IA Principles of Remuneration are not ‘legal rules’, but they have persuasive influence. The IA highlights breaches of the guidelines to their members. This might result in shareholders voting against proposals or, at least, bad publicity.

Question 47

TEST YOURSELF:

10. When do the IA Principles suggest grants of awards should occur?

Answer 47

Grant should only be made within the 42 day period immediately following the end of the closed period under the Market Abuse Regulation – generally the announcement of results.