Consequences of Having a Minimum Equity Holding Policy
For those individuals with substantial financial resources a minimum equity holding policy may be of little consequence. In addition, for such individuals the holding of equity in the company may be a minor part of their personal financial resources with the result that having skin-in-the-game may not impact their decision making in the way expected by those proposing that NEDs have equity holdings of 2 to 3 times annual fees.
For NEDs with modest financial resources, the requirement to hold significant equity may be an impediment to them accepting appointments as NEDs. It is now common, particularly on boards seeking diversity, for professionals to take up NED roles mid-career before they have had the opportunity to accumulate significant financial resources. This cadre of NEDs, as opposed to the traditional NED being an older retired senior executive, has many benefits, including diversity and freshness of opinions, and should be encouraged rather than discouraged by placing an equity holding barrier to becoming NEDs.
A view presented in the article is that individuals who need the income they earn as fees and therefore may not be able to afford to acquire significant equity holdings probably should not be appointed as NEDs because their reliance on the fees for income may taint their ability to fulfil their fiduciary responsibilities. GRG does not see a lot of merit in this view.
Conclusion: A Prudent Way Forward, Balancing Stakeholder Needs
Considering the foregoing discussion, a prudent way forward may be to introduce a policy under which say 30% of board fees are compulsorily paid on a pre-tax basis in equity and NEDs are required not to dispose of equity while they hold the office of NED. If done on an ongoing basis, holdings can be expected to exceed even the proposed new higher levels, in a more sustainable and fairer manner. This approach means that NEDs will not have to divert existing investment into company shares and will not need to borrow to fund share acquisitions.
Ignoring share price volatility, NEDs would accumulate equity with a value of 90% of board fees after three years, 180% after 6 years and 270% after 9 years. Assuming a properly structured arrangement, tax would be deferred until the earlier of cessation of disposal restrictions and the elapse of 15 years after the equity was acquired. Also, assuming the equity transitions into shares soon after it is acquired, the NEDs will receive dividends on the full amount of equity held. Assuming a ~50% tax rate they will also reach the desired minimum shareholding twice as fast as traditional approaches. A challenge for NED equity plans has been the use of plans designed for executives, which typically creates a trigger for NEDs to be taxed and thus forces them to sell into the market. With up to 15 years of tax deferral on the shares received, NEDs will not be forced to sell into the market to pay tax under GRG’s proposed approach, unless they exceed current typical term limits. For governance and independence reasons, NED equity plans should always be operated as a separate and discrete plan from any other plan, in any case.
GRG’s proposed approach balances the needs of various stakeholders by:
- Accelerating holding accrual compared to current typical approaches.
- Ensuring NEDs are not financially disadvantaged.
- Providing tax advantages through Employee Share Scheme (ESS) tax treatment.
- Ensuring that there are sufficient cash funds in the NED remuneration mix to support diversity.
- Facilitating holding requirements that will accrue to a level or multiple of board fees that far exceeds current standard approaches, in a sustainable and fair manner over time.
- Avoiding point-in-time issues to do with the circumstances of a NEDs appointment.
Given the favourable treatment available under new equity plan frameworks, and the requirement for all equity plans to be amended or replaced to comply with the Corporations Act from 1 March 2023, now is a great time to think about NED equity plan optimisation.