Where STI is deferred, recent court rulings compel this to be clearly articulated in all STI plan documentation – and to be clear about when the reward has been “earned”. Large companies should review their current STI deferral practices, and smaller companies should introduce STI deferral in line with best practice.
GRG Remuneration Insight 179
22 July 2025
Understanding Short Term Incentive (STI) Deferral
Short term incentive (STI) deferral refers to the practice of delaying the payment or settlement of part of an STI award; that is sometimes done via a “bonus bank” but is more often in the form of equity instruments that cannot immediately be converted into cash via a sale process. Often the deferred amount may be subject to satisfaction of further conditions beyond those that determined the short term award amount, before the deferred component becomes fully vested. Once deferred cash STI awards vest the cash values are then paid via payroll. Once deferred STI equity instruments vest they may be exercised and the shares sold unless they remain subject to a disposal or exercise restriction for an extended period.
Legal Considerations for STI Deferral in Australia
GRG Remuneration Insight 176, “Court Case Triggers Review of STI Plans”, drew attention to a court case which highlighted the fact that STI deferral of earned STI awards may not be legal in certain circumstances.
The case indicated that letters of appointment, remuneration review advice, STI plan rules, STI offers and STI explanatory materials need to be consistent and clearly articulate that STI awards will be partly delivered on a deferred basis. Most importantly, they need to be clear about when the reward has been “earned”, as any attempt at reducing awards once they have been earned are likely to be deemed to be unenforceable.
Cash vs Equity Instruments: STI Australian Market Practice
The practice of STI deferral emerged after the Productivity Commission’s Report which followed the Global Financial Crisis (GFC). A conclusion of the Report was that STIs in the finance sector generally failed to hold executives to account for the negative long term consequences of activities that maximised STI awards. To address this problem, it was recommended that part of STI awards be deferred for a period during which the value of the deferred STI awards would be exposed to longer term company performance. The Government has attempted to mandate this for companies in the finance sector that are covered by the Financial Accountability Regime (FAR) through compulsory deferral of part of total incentive awards (STI & LTI) for specified executive roles where total incentive awards exceed a minimum amount. Most companies achieve this by deferring part of STI as well as extending LTI periods, though it is recognised that some achieve it without STI deferral in a minority of cases.
Prior to the introduction of FAR and its predecessor, the Banking Executive Accountability Regime (BEAR), companies across many sectors introduced STI deferral in response to the Productivity Commission’s recommendation. Given the complexity of attempting to track the long term negative consequences of activities that influenced STI awards, most boards chose to deliver the deferred element of STI awards in the form of equity instruments, the subsequent value of which would be influenced by long term company performance.
At the same time, proxy advisors and other stakeholders took the opportunity to draw attention to the relatively low value placed on LTI, believing that executives should have significant “skin-in-the-game” by holding equity interests in their employer company, and saw the push for deferral as an opportunity to increase long term and equity alignment. They also appear to accept that the fairest and quickest way of bringing this about is for part of STI awards to be deferred into equity interests. LTI awards generally take at least 3 years to vest and thereby create vested equity interests for executives.
As a result of the foregoing factors, cash deferral of STI awards has become rare, mainly limited to unlisted companies where there is no market for equity interests.
Shares vs Rights: Tax Optimisation for Australian Executive
Irrespective of whether shares or rights are used to deliver deferred STI awards it is important for the point in time when executives may convert the equity interests into cash to coincide with the time when personal income tax arises in relation to the deferred equity interests, or to ensure that this is a time that is able to be chosen by the executive. This allows executives to fund the tax payable from the sale of shares (rights need to be exercised into shares at that time) and for the cash received from the sale to equal the taxable value of the deferred STI.
In relation to deferred STI that is delivered in shares, delaying of the taxing point until the shares may be sold requires several conditions to be satisfied including:
- 75% of permanent Australian employees with 3 or more years of service having received an offer under an employee share scheme operated by the company,
- there is a real risk of forfeiting the shares i.e., vesting conditions, and
- a disposal restriction applies to the shares for a period (needed to defer the taxing point beyond the vesting point).
Only the third condition applies to salary sacrifice into shares but the maximum amount that may be sacrificed each year is $5,000.
These conditions make the use of shares less attractive than the use of rights.
In relation to deferred STI that is delivered in rights, none of the foregoing conditions need apply to the rights. It is only necessary that the rights are restricted from being disposed of immediately.
For both shares and rights there are a number of other conditions that need to be satisfied such as the shares being ordinary shares. Also, the maximum tax deferral period is 15 years. However, payment of tax may be delayed much longer, if certain types of rights are used.
In the case of rights, they become taxable when they are exercised, if there are no disposal restrictions attached to the shares acquired on exercise of the rights.
Provided that rights holders are entitled to dividend equivalent (cash dividend + value of franking credits) payments from the company, rights represent a much more flexible alternative to shares for STI deferral Alongside a tax advantage equivalent to a CGT rate of nil on future gains, compared to alternatives, providing participants with a flexible taxing point means that rights are clearly the best approach.
It should be noted that up until fairly recently, a risk of forfeiture, essentially “vesting conditions” were required to obtain the tax advantages, but that is no longer the case.
Market Practice – Executive Remuneration Survey
The following data was extracted from GRG’s Executive Remuneration Survey to outline what current market practice is.
The following table presents the incidence of STI deferral, differentiating between those that apply vesting conditions to the deferred amount and those that do not.
From the foregoing table it is clear that STI deferral is more prevalent among larger companies. It is also clear that the attachment of vesting conditions to deferred STI is the dominant market practice i.e. dominant market practice indicates that most companies have not updated their approach since the changes to the tax framework.
Implementation Strategy for Australian Companies
The following table indicates the relative use of rights, shares and cash among large companies.
Given that only 35% of companies use shares for STI deferral, it follows that the need for vesting conditions to qualify for tax deferral which now only applies to shares, does not explain the dominant market practice of applying vesting conditions to deferred STI awards. Possible explanations include: retention and promoting skin-in-the-game but the latter does not require vesting conditions which dilute the sense of ownership. It is more likely that those with oversight of the arrangements simply have not seen it as a priority to make the changes, despite the obvious advantages.
Vesting Conditions and Periods
When vesting conditions are applied to deferred STI awards it is almost universally service and not performance related. This reflects that STI awards have been earned by performance during the STI measurement period and therefore to apply a second set of performance conditions would be excessively onerous. It can also be argued that applying a service vesting condition to deferred STI awards is similarly excessive and unwarranted unless the organisation takes the view that the STI has not yet been “earned”, which is rarely, if ever the case in the way that STI structures are described to employees.
The following table shows market practice among large companies with service vesting conditions.
Malus and Clawback: Risk Management for Australian Companies
Many companies have Malus & Clawback policies which allow recovery and/or cancellation of STI and LTI awards, unearned or previously delivered, when warranted by bad behaviours or errors in accounting records. When STI awards are deferred into equity instruments and subjected to a holding period before they may be converted to cash there should be ample scope for recovery or cancellation. Subjecting deferred STI awards to service vesting is a poor way of attempting to create a pool to which malus and clawback may be applied.
Retirement Benefit Limits: Corporations Act Compliance
Under the Corporations Act (s200–200j) retirement benefits for executive and managerial officers are limited to one times average annual base salary unless shareholders have approved a higher retirement benefit. For deferred STI awards that are subject to vesting conditions the foregoing limit will apply to vesting which the board wishes to bring forward in the event of a termination of employment. Thus, the board may not be able to trigger or accelerate vesting unless shareholder approval is obtained. In this regard the limit applies to the total amount of retirement benefits which can include part year STI awards for the year of termination, early LTI vesting and early deferred STI vesting.
Conclusions
The following features may be regarded as best practice and are consistent with FAR and indeed modern institutional investor views of variable remuneration governance, to manage the risks inherent to STI:
- Up to 50% of STIs should be deferred,
- Deferral should be into equity instruments,
- No vesting conditions neither service nor performance should apply to the equity instruments,
- Holding of equity instruments should be for a minimum of 3 years, and
- Clawback should be able to be applied to deferred STI equity instruments.
Such a policy would be well regarded practice by proxy advisors and other stakeholders. It should also be acceptable to senior executives.
Large companies with STI deferral should review their current practices with a view to bringing them into line with best practice. Smaller companies should consider introducing STI deferral in line with best practice.
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