Catching the Next Wave

Transcription

1 Aon Hewitt Performance, Reward & Talent Catching the Next Wave Third Generation of Long-Term Incentive Plans in Singapore March 2015 Risk. Reinsurance. Human Resources.

2 II Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

3 Table of Contents Executive Summary....2 Introduction...3 Assessing the Impact of the Second Generation Long-Term Incentive Plans....4 Shareholders Organisation Employees Aon Hewitt Point of View on the Third Generation Long-Term Incentive Plans in Singapore....9 Stock Options Will They Make a Comeback?... 9 Restricted Shares Retention or Resentment? Performance Shares Pay for Performance or Say for Performance? The Way Forward Reference Notes Aon Hewitt 1

4 Executive Summary Long-Term Incentive (LTI) Plans have been in existence in Singapore for nearly two decades. They are an integral part of the executive management remuneration structure, and constitute as much as one-third of the total compensation in many large cap Singapore companies. The structure of LTI Plans has evolved significantly during this time. Most companies transited from stock options to share awards after the first cycle, and many of them have renewed their plans recently, or will be obtaining approval from the shareholders in the not-so-distant future. Aon Hewitt conducted a research study on the effectiveness of the second-generation share plans from the perspective of shareholders, employees and the organisation. Our study reveals mixed results. From a shareholder standpoint, 60% of the 30 companies in the Straits Times Index (STI) did not generate sufficient Total Shareholder Returns (TSR), after adjusting for the dilution impact of the LTI. Nevertheless, the awards from many such plans have vested partially. From an organisation standpoint, more than 60% of these companies incurred accounting costs on LTI that were significantly higher than the actual value delivered to employees, with deviations of up to 50% between the two numbers. From an employee standpoint, most employees within these companies view the plan to be attractive, intuitive and fair. Put in perspective, the results indicate that LTI plans in Singapore have been reasonably successful in attracting and retaining talent. However, it also raises questions about the pay for performance alignment of the LTI plans, particularly on the design of performance criteria and targets. Aon Hewitt believes that there are a number of potential refinements that Singapore companies can consider to their LTI design and incorporate them in their third generation plans. Some of the salient ones would include: Where business case exists, complement existing Restricted Share and Performance Share Plans with selective and prudent use of stock options to drive transformative growth In addition to financial performance, allocate a reasonable weight towards non-financial performance as vesting criteria, to encourage management towards building a sustainable corporation, and not merely focus on medium-term financial results Where relevant, extend performance period beyond the current norm of three or four years to measure the true impact of business transformation Achieve the right balance between Absolute and Relative Total Shareholder Return (TSR) performance measures, and take into account the firm s and the peer companies hurdle rates while developing the performance targets on these criteria Measure relative performance more systematically, and pay particular attention to the choice of peer companies and the methodology for computing relative performance 2 Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

5 Introduction Given Singapore s strong ecosystem of corporate governance and shareholder activism, it is no surprise that many companies in Singapore have embraced Long-Term Incentive (LTI) plans as early as 1990s. Today, LTI awards for executive management in large-cap Singapore companies constitute more than 30% of their total remuneration. The profile of LTI plans has evolved significantly over the last few decades. The first wave of LTI plans in Singapore started with stock options in the late 1990s. This period also coincided with a phase of rapid growth in the stock market, and reflected the general emphasis of Singapore corporations towards aggressive growth and cash preservation. Stock options were an attractive proposition since they fitted the business requirements and offered employees the prospect of significant wealth creation through share price appreciation. However, during early to mid-2000s, stock options lost their lustre and Share Plans gained precedence as the LTI vehicle of choice. The key reasons behind the shift from stock options to share plans can be seen in Table 1 in the Reference Notes section. Fast forward another decade, the second generation LTI plans is scheduled for renewal. Many Singapore companies are exploring refinements to their LTI plans. In this article, we assess the impact of the existing LTI plans, by considering the extent to which they have met the objectives of Shareholders, Organisation and the Employees. We then address opportunities to finetune the current plans and develop a point of view on the third-generation LTI plans that we foresee to emerge over the next few years, as shown below in Exhibit 1. Exhibit 1: Evolution of Long-Term Incentive Plans in Singapore LTI Plan evolution Third generation?? First generation Stock Option Plans Focus on aggressive growth and share price appreciation, reflecting the general pulse of the economy and the stock market Favourable accounting treatment for Stock Options vis-à-vis Share Awards Second generation Restricted and Performance Share Plans New accounting standards eliminate accounting subsidy for Stock Options Reality check on stock price appreciations Focus on balanced and sustainable growth Focus on business renewal and transformative growth Balancing retention and performance objectives through more intuitive and simple mechanisms Rewarding for real performance, that is measured on a level playing field Late 1990s Early 2000s Mid 2000s Mid 2010s Mid 2010s and beyond Business Life Cycle Aon Hewitt 3

6 Assessing the Impact of the Second Generation Long-Term Incentive Plans Most second generation LTI plans in Singapore use a combination of Restricted Shares and Performance Shares and an overview of these two types of LTI vehicles can be found in Table 2 in the Reference Notes section. To assess the effectiveness of these second generation LTI plans more holistically, we considered perspectives of three stakeholders impacted by the plans Shareholders, Organisation and Employees, as shown in Exhibit 2. Exhibit 2: Assessing the Effectiveness of Second Generation Long-Term Incentive Plans Key Issues Examined Are Long-Term Incentives effective in attracting and retaining talent? Is the plan cost effective i.e. is the accounting cost of the plan comparable to the value realised by employees? Organisation Effectiveness of Long-Term Incentive Plans Employees Do employees view the plan as fair and simple enough to understand? Do they consider that the plan significantly enhances their total compensation opportunity? Shareholders Is the vesting of shares/share units sufficiently aligned with returns to shareholders? Does the increase in shareholder value off-set their dilution in equity as a result of the plan? Shareholders Globally, there are multiple proxy advisors such as Institutional Shareholder Services (ISS) which assist shareholders to assess the LTI plans and their alignment to shareholders interests. One of the many components that shareholders take a particular interest in is the alignment of equity awards with shareholder value. The most commonly used measure of shareholder value is Total Shareholder Return (TSR). Aon Hewitt analysed the 3- Year TSR for the top 30 listed companies in Singapore that have an LTI plan. We collated the vesting of grants awarded during the Financial Years 2009, 2010 and 2011, and compared this against the 3-year TSR for the corresponding performance period for each grant i.e performance period for FY 2009 grant, performance period for FY 2010 grant, and performance period for FY 2011 grant, as seen in Exhibit 3. However, the correlation is lower as we compare the TSR over Cost of Equity (COE), as seen in Exhibit 4. This could indicate that some companies do not adequately factor in COE in developing the performance hurdles for vesting of LTI. 4 Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

7 Exhibit 3: Correlation of 3-Year TSR with Long-Term Incentive Award Vested 60% 50% R² = % 3-Year TSR 30% 20% 10% 0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 200% -10% Percentage of Awards Vested Data Source: Company Annual Reports, Aon Hewitt analyses Number of companies: 30 Exhibit 4: Correlation of 3-Year (TSR-COE) with Long-Term Incentive Award Vested 60% 50% R² = % 3-Year (TSR-COE) 30% 20% 10% 0% 20% 40% 60% 80% 100% 120% 140% 160% 180% 200% -10% Percentage of Awards Vested -20% Data Source: Company Annual Reports, Aon Hewitt analyses Number of companies: 30 Aon Hewitt 5

8 Any LTI plan is valuable to shareholders; if the shareholder returns (including price appreciation and dividends) adjusted for the dilution impact of LTI grants exceeds the hurdle rate i.e. Cost of Equity (COE). This concept is illustrated in Exhibit 5. As shown in Exhibit 5, the initial market value of the firm is represented by (A). Shareholder expect their investment to generate returns that are equal to their hurdle rate i.e. COE, at a minimum. Therefore, if LTI grants are made to employees of the company, existing shareholders will expect their return netted for the share of management, to be greater than the COE i.e. (C) > (B). Exhibit 5: Shareholder Return vs. Dilutive Impact of Long-Term Incentive Plans Expected Shareholder Value without Equity-based Grant (B) Increase in shareholder value at Cost of Equity Overall Shareholder Value at date of grant (A) Overall Shareholder Value at date of grant (A) Expected Shareholder Value with Equity-based Grant Value share of management (D) i.e. portion of (C) For net shareholder value creation (C) > (B) Overall Shareholder Value at date of grant (A) Overall shareholder Value (C) Using this principle, we computed the adjusted shareholder returns of the top 30 companies in Singapore with an LTI plan over three performance cycles (FY , FY and FY ). Subsequently, we compared the result against their COE. Our findings, as seen in Exhibit 6, indicates that nearly 60% of LTI awards did not generate sufficient shareholder return over the COE after adjusting for the dilution impact of the LTI. However, it is interesting to note that most of these LTI awards have vested partially. Exhibit 6: Shareholder Return vs. Dilution of Long-Term Incentive Plans (% of Companies) Adjusted Shareholder return less than COE, 59% Adjusted Shareholder return greater than COE, 41% During the period , majority of companies in our sample delivered Adjusted Shareholder Returns below Cost of Equity. However, many of their Performance Share Awards have vested partially. Data Source: Company Annual Reports, Aon Hewitt analyses Number of companies: 30 6 Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

9 Organisation From an organisation standpoint, LTI can help attract and retain talent to enable business continuity and sustainable growth. We conducted a dipstick survey amongst business and HR leaders of 15 Singapore-based companies to gather feedback on their current LTI plans. More than 70% of the surveyed companies agreed that LTI plans help the business in attracting and retaining talent. However, as seen in Exhibit 7, two-thirds of the surveyed companies reported that they did not achieve the pre-determined targets on the performance condition(s) linked to LTI vesting. Only 29% of the surveyed companies have exceeded the pre-determined performance targets, and less than 5% of the surveyed companies achieved performance outcomes within a range of +/- 10% of the target. In addition, from a business standpoint, the accounting costs of the plan should not be significantly higher than the realised value to employees to ensure than the plan is cost effective. To assess cost effectiveness of the plan, we analysed the LTI compensation costs incurred by the top 30 companies in Singapore that have an LTI plan, and compared them against the realised value over a 3-year period. We conducted this analysis over three award cycles covering FY 2009, FY 2010 and FY On average, the deviation of the realised value to the employee from the accounting value is as much as +/- 50%. In Exhibit 8, it is also interesting to note that around 60% of the companies have a lower realised value to employees as compared to the cost recognised in their financial statements. To a certain extent, we believe that this misalignment is created by the accounting guidelines, which specify that accounting expenses of grants with market-based performance condition(s) cannot be trued-up based on actual performance achieved. Exhibit 7: Achievement of Long-Term Incentive Performance Targets (% of Companies Achieving LTI Targets) Significantly Under Achieve (Vesting <50%) 33% Under Achieve (Vesting 50% - 100%) 33% Over Achieve (Vesting >100%) 29% At Target (Vesting = 100%) 5% More than one-third of the companies included in our survey responded that their award vesting was significantly below the target. Data Source: Aon Hewitt dip-stick survey Number of companies: 15 Exhibit 8: Accounting Cost to Company vs. Realised Value to Employee (% of Companies) Realised Value Greater than Accounting Cost 39% Data Source: Company Annual Reports, Aon Hewitt analyses Number of companies: 30 No Realised Value 15% Realised Value Less than Accounting Cost 46% During the period , majority of companies in our analyses have recognised higher accounting costs than the value that employees have realised. Persistent misalignment between accounting costs and realised value indicates a need to review the Long-Term Incentive plan design. Aon Hewitt 7

10 Employees From an employee standpoint, the plans should be able to motivate the employees to drive the desired performance levels, and should provide them an attractive compensation opportunity. From the dipstick survey, we also secured feedback from an employee perspective. As shown in Exhibit 9, the responses seemed to suggest that employees are generally satisfied with the current LTI plans. Exhibit 9: Assessing Satisfaction of Long-Term Incentive Plans Based on Key Areas of Feedback Percentage of Organisations Satisfied LTI enhance the total compensation opportunity 93% LTI motivate and reinforce focus on long-term goals 87% LTI are simple and easy to understand 100% LTI add value to the organisation s objectives 73% Generally, I am satisfied with how the LTI is working 73% Data Source: Aon Hewitt dip-stick survey Number of companies: 15 Exhibit 10: A Summary Assessment of Second Generation Long-Term Incentive Plans Majority of organisation leaders regard that the plan is effective in terms of attracting and retaining their talent However, most of them also perceive that the plan may not be cost effective i.e. accounting cost is higher than realised value to employees Organisation Effectiveness of Long-Term Incentive Plans Employees Majority of organisations surveyed view that employees consider the plan as attractive, fair and simple enough to understand Shareholders Across the board, shareholder returns adjusted for dilution in equity are below expectations (Cost of Equity) In summary, the second generation LTI plans in Singapore have had mixed results. To be fair, Remuneration Committees and HR leaders have been exploring these issues objectively, and have demonstrated keenness in exploring alternative solutions. As many firms are expecting to renew their LTI plans in the near future, we believe it is an opportune time for them to bring these improvements to fruition. 8 Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

11 Aon Hewitt Point of View on the Third Generation Long-Term Incentive Plans in Singapore As the second generation plans expire, Aon Hewitt has been commonly asked by our clients to provide our point of view on many pertinent questions, such as: 1. In what form should the next generation of LTI plans be delivered? Options, Restricted Shares, or Performance Shares? 2. What performance measures should be used to provide optimal alignment with shareholders interests? 3. How do we set the bar on these performance measures and how do we measure the actual performance in an objective manner? In this section, we will explore possible answers to these questions based on our consulting experience. We begin by stating the usual disclaimer. There is no one magic pill, and there are always trade-offs and difficult choices that firms need to make as they tailor the plans to their context. Stock Options Will They Make a Comeback? As highlighted earlier, stock options have had their heydays before they fell out of favour. However, in our view, stock options may actually benefit shareholders and employees alike under certain circumstances. Logically, early, fast growing companies continue to award stock options because: 1. Stock options help conserve cash. 2. The upside potential is high should the share price increase significantly. However, for most mature companies, share prices remain fairly flat as investors expect businessas-usual status and draw down on generous dividends. However, some of these mature companies may also look to transform and drive a second wave of growth. One of our utilities client was facing a similar situation. It was a mature company in a regulated industry experiencing stagnant growth. Their share price was stable and dividend payouts constant. However, the new management sought to transform the business model through organic and inorganic growth in complementary businesses. The business projections were encouraging and management expected the earnings and share price to appreciate noticeably. In this case, the share price appreciation would never materialise if not for the transformation. Therefore, it was appropriate for the LTI to be delivered in the form of stock options as it motivated management to focus on making the transformation happen. A common criticism of stock options is that it may encourage management to drive short-term, unsustainable share price spikes closer to the exercise date, and then cash out at attractive sums of money. This can be circumvented by awarding a one-off grant tied to an aspirational share price. Thus, there is less leverage to create volatility, and game the system due to less sensitivity to the prevailing market price. Consider onetime grant tied to aspirational share price to circumvent excess risk-taking Aon Hewitt 9

12 To counter the disadvantages of stock options mentioned earlier, possible solutions do exist: A. Tie Stock Options to Real Performance Achievement Opponents of stock options argue that it does not reward for real performance. Performance options can address this issue reasonably well. These options have vesting performance conditions tied to certain profitability or return measures. For example, an option award could vest after three years only if management hits stretch targets on the bottom-line or Return on Invested Capital. B. Include Stock Options Under an Omnibus Plan Another criticism of stock option is that it loses its retentive element when the options are underwater i.e. share price is below exercise price. However, it may not be an entirely fair criticism as the main purpose of stock option plans is not to drive retention. It is meant to drive aggressive share price growth primarily. We recommend an alternate vehicle such as restricted shares to deliver the intended retention effect. Using a portfolio approach of options and restricted shares can provide a better balance between pay for performance and retention. Selective and prudent use of stock options with performancebased vesting hurdles can mitigate the limitations traditionally attributed to them. Further, businesses that are seeking to drive transformative, step change growth can use stock option awards on a one-off basis to motivate management. C. Grant Awards More Selectively to Limit Dilution Institutional shareholders have criticised stock option plans due to the higher dilutive effect visà-vis Restricted or Performance Share Plans. While this is valid, this is due to the fact that grants were made indiscriminately in the past. Frequently, stock options were given to a broader group of employees with no line-of-sight to share price growth, and in unsustainable numbers to boost their compensation. With a more conservative award size that is limited to senior management, dilution will be limited and can also be capped at an acceptable level. Restricted Shares Retention or Resentment? Restricted shares are increasingly common as a vehicle to deliver long-term incentives. Conceptually, restricted shares serve as a great retention tool, since share vesting is dependent upon continued employment with the company. They also increase employee alignment with company interests because of the share ownership. However, most Singapore companies utilising restricted shares have taken to the practice of imposing a 1-year performance period as a vesting criterion. As a result, restricted shares become almost indistinguishable from performance shares to the employees. This can breed resentment on the rare occasion when restricted shares do not vest. Employees sometimes take it for granted that once awarded, restricted shares will definitely vest so long as they stay with the company. This entitlement mentality can cause resentment, if and when the performance conditions are not met. Also, employees may discount the value of restricted shares with a performance requirement, since the payment is not guaranteed. Thus, a performance criterion may dilute the value of restricted shares as a retention tool. Performance Shares Pay for Performance or Say for Performance? Performance share plans are generally well received by shareholders as they present the best pay for performance alignment. However, are these performance shares really paying for performance or do they merely give an impression of alignment to performance? The choice of performance measure for long-term incentive plans fits into the overall performance framework and drives sustainable performance. Also, it is critical for executives to be measured on indicators correctly to drive the right behaviour. 10 Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

13 A. Measuring the Right Performance The most commonly used metrics for Performance Share Plans in the Singapore market in order of their frequency are: 1. Absolute Total Shareholder Return (ATSR) 2. Relative Total Shareholder Return (RTSR) 3. Return on Equity (ROE) 4. Economic Value Added (EVA) It is immediately noticeable that these metrics are return measures focused on aligning with shareholders interests. However, there are flaws and limitations with each of those metrics. For instance, ATSR may reward and penalise management for macroeconomic drivers not within their control. While it can be argued that this creates perfect alignment with shareholders interests, it may result in free riding during buoyant times and loss of talent during adverse times. Therefore, while these return measures are relevant, they may need to be balanced with relative measures. Many companies have used RTSR against a regional industry index or a country index as an additional performance measure. While the notion of using RTSR as a counter-balance is intuitive, measuring relative performance is not so straightforward. Many companies may not have been using an apples to apples comparison when doing so. Also missing as criteria in most LTI plans are non-financial, leading indicators of performance. The argument is that if the managers pay attention to these factors, it should lead to increase in the form of TSR or higher earnings multiple. However, in reality, the market is not perfect. As a case in point, succession planning has been acknowledged as one of the key remits for top executives to ensure a sustainable corporation. However, whether a robust succession plan will have tangible effects on the TSR is questionable, since shareholders may not have visibility to the foundation laid by the top executives. Therefore, the company may not enjoy the benefits of a good succession planning system until the next wave of leadership change, which may be beyond the time frame of the LTI performance period. Thus, a key element of long-term sustainable performance is left unrecognised. Include non-financial indicators of performance to ensure that management prioritises building a sustainable firm instead of merely focusing on financial results. Conventionally, boards have avoided rewarding executives with equity for performance on non-financial measures. But we believe that the time is ripe to consider allocating some weight towards non-financial measures to provide better balance and direct managerial behaviour to build a sustainable corporation that may not be immediately apparent but is nonetheless, pivotal. B. Measuring the Performance Right After choosing the right performance metric, boards must also decide how best to measure the metric and make executives accountable for it. We highlight below salient performance measurement issues that we observe in current plans. i. Methodology of Computing Total Shareholder Return (TSR) As seen below, there are predominantly two ways in which ATSR achievement is measured: 1. Using average annual TSR over a period of time. 2. Using point-to-point compounded annualised growth rate (CAGR) Both methods measure the TSR achievement over a multi-year period and in our studies, we find that the difference between both methods is usually minuscule. However, as shown in Exhibit 11, under some circumstances, where the TSR performance is very volatile or oscillates between positive and negative TSR, the former method of averaging annual TSR may result in distorted results. Aon Hewitt 11

14 Exhibit 11: Difference Between Average TSR and CAGR TSR Achievement When Share Price Remains Unchanged TSR Share Price $1.00 $0.75 $1.00 Share Price Unchanged $ % 33% Simple Average = 11% CAGR = 0% -50% Year 0 Year 1 Year 2 Year 3 While most companies use the CAGR method, its main criticism is that it is sensitive only to the start and end points and totally ignores the movements in between. This creates an overemphasis on the share price at the end of the performance period and could skew results. The current market standard is to use the starting and ending share price averaged over a month. We believe that this is an adequate measure to smooth out any volatility due to shortterm shocks to the share price. ii. Selection of Peer Group for Relative Total Shareholder Return (RTSR) Typically, RTSR is measured based on performance of the company against an established index. The choice of index is usually decided on 2 dimensions: 1. Geography, reflecting constituents that operate in similar geographies 2. Industry, reflecting constituents that is within a similar industry Choosing an inappropriate peer group may create distorted outcomes. For example, the COE for a Singapore-based airline company would be relatively low compared to other regional airlines that operate in developing countries like China or Indonesia. Should the regional index comprise companies that operate primarily in developing markets, the Singapore-based airline company will seem to perform consistently below the performance level of the index. This is simply because the index constituents have a higher risk profile than the company, and therefore the COE will be higher. To outperform the index, the company will have to outperform its COE by a few multiples greater than its peers. This may not make intuitive sense and is also unfair to management. We recommend measuring Relative Shareholder Return after adjusting for differences in Cost of Equity between different peer companies in the index. This approach eliminates distortion created by different risk profiles of individual companies and is a fairer gauge of relative performance delivered by management. Therefore, to level the playing field, companies should consider measuring RTSR using TSR performance over COE, which we refer to as the Relative Total Shareholder Return Multiple (RTSRM) method. When this method is applied, we find that it is a better representation of performance, since it is adjusted for differences in risk profile and shareholder return expectations across different companies in the index. iii. Percentage Outperformance vs. Percentile Ranking There are two predominant methods of measuring relative outperformance. One method measures the percentage over the index achievement while the other ranks the position of the company against the constituents of the index. The former method may seem more 12 Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

15 straightforward and is commonly used to measure RTSR performance in most plans. However, outliers can also skew the results easily. Therefore, the ranking method is preferred when there is presence of many outliers in the index, which can be the case when the constituents are made up of companies operating under more volatile conditions. For established and stable indices, the percentage outperformance method is preferred. iv. Should I have both ATSR and RTSR in our Performance Share Plans, and if so, what would be the ideal weight or ATSR and RTSR? According to the findings in Exhibit 12, the most common market practice for the above question is to have equal or nearly equal weights for ATSR and RTSR measures. This is to provide a counterweight for some of the limitations of ATSR. We believe this approach is effective as long as we consider the hurdle rate meaningfully in setting the performance targets for both measures. By incorporating the hurdle rate, companies will pre-empt outcomes that provide an inconsistent picture of pay for performance e.g. management has significantly underperformed shareholder expectations but RTSR has significantly outperformed the index, resulting in high vesting. Exhibit 12: Weights of ATSR and RTSR in PSP (% of Companies Using ATSR and RTSR in PSP) Cost of Equity should be considered as an important parameter in setting performance targets on both Absolute and Relative Shareholder Return measures. This will help avoid traps where management seems to perform exceptionally well on one measure, but very poorly on the other. Only RTSR 18% ATSR Higher Weight 18% Both ATSR and RTSR 64% Only ATSR 18% Equal Weight 46% Data Source: Company Annual Reports, Aon Hewitt analyses Number of companies: 30 Aon Hewitt 13

16 The Way Forward Most Singapore large cap companies have made the transition from stock options to Restricted Shares and Performance Shares over the last decade. The plan structure is also very similar across companies. Going forward, we foresee Remuneration Committees to take a more customised approach, by bringing together a broader range of issues as seen below into consideration: 1. Considering a portfolio approach by complementing Restricted Share Plans and Performance Share Plans with selective and prudent use of stock options to drive transformative growth. 2. Expanding the performance criteria by considering non-financial indicators of business sustainability. 3. Defining sustainable performance to extend beyond the three or four year horizon. 4. Achieving the right balance between Absolute and Relative Shareholder Return performance. 5. Rewarding for Relative Performance on a normalised and level playing field. 14 Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

17 Reference Notes Table 1: From Stock Options to Share Plans 1. Stock options have greater dilutive impact All things remaining the same, the intrinsic value of an option is less than the value of the share. Therefore, firms issuing stock options must compensate employees for the higher risk, hence resulting in a greater number of stock options awarded, as compared to shares. This results in a higher equity dilution for option plans as compared to share plans. 2. Revision in accounting standards nullifies accounting advantage of stock option Previous accounting standards allowed companies to avoid expense impact for stock options if the exercise price of the options is the same as the market price of the underlying share. This created an accounting subsidy for options as compared to shares. With the change in accounting standards, Singapore companies are required to use the fair value accounting method for all forms of equity-based employee compensation and recognise as expense in their financial statements. Companies that have previously adopted stock options to exploit the accounting advantage were unable to do so henceforth. 3. Underwater stock options can be detrimental to employee morale and retention Employees incur a higher risk on stock option plans because there is no downside protection when the exercise price is above the market share price and the realisable value is zero (i.e., the employee receives no payout). This dilutes the intended purpose of the long-term incentive to retain and motivate the employees. On the contrary, for share plans, there will still be some realisable value to the employees during share price declines, as these are issued free to the employee. 4. Stock options may induce excessive risk-taking Stock options might create potential misalignment between management and shareholders, where participants have unlimited upside but no downside. This may incentivise management to take unnecessary risks to drive short-term, unsustainable share price increases to increase personal wealth. 5. Stock options may not provide direct line-of-sight to all employees Many stock option plans were extended to all employee levels, many of whom did not have a clear line-of-sight to drivers that impact stock price. In contrast, vesting of share awards can be linked to specific qualitative and quantitative performance metrics derived from the company s strategic goals and budgets. Since share awards placed less emphasis on share price appreciation and enabled greater line-of-sight to employees at all levels, they could be extended to a broader group of employees. Table 2: Primer on Restricted Share Plan and Performance Share Plan Feature Restricted Share Plan (RSP) Performance Share Plan (PSP) Objective Driving retention Driving superior and sustainable shareholder performance Eligibility Senior management Top management with direct line-of-sight to the Company s performance Grant frequency Annual Annual Vesting duration and schedule Graded vesting, typically over a 3-year period Cliff vesting, typically at the end of three years Grants vest completely at the end of the performance period based on achievement against pre-set performance targets Performance condition Typically, RSPs do not have performance condition(s) However, the common practice in Singapore is for RSPs to have performance condition(s) linked to vesting These performance condition(s) are expressed as a minimum hurdle that management has to meet on financial performance (e.g. Return on Equity, Net Profit) Generally linked to shareholder value creation E.g. Total Shareholder Return, Economic Value Added Performance Period One year Three years Aon Hewitt 15

18 Contacts Kumar Subramanian Partner, South East Asia Ronak Marolia Senior Consultant, South East Asia Kuan Feng Yi Consultant Jacob Tan Consultant About Aon Hewitt Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organizational and personal performance and growth, navigate retirement risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. Aon Hewitt is the global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt in Asia Pacific, please visit 16 Catching The Next Wave: Third Generation of Long-Term Incentive Plans in Singapore

19 Aon Hewitt 17

20 About Aon Aon plc (NYSE:AON) is the leading global provider of risk management, insurance and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 66,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative and effective risk and people solutions and through industry-leading global resources and technical expertise. Aon has been named repeatedly as the world s best broker, best insurance intermediary, best reinsurance intermediary, best captives manager, and best employee benefits consulting firm by multiple industry sources. Visit aon.com for more information on Aon and aon.com/ manchesterunited to learn about Aon s global partnership with Manchester United. Aon plc All rights reserved. The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. Risk. Reinsurance. Human Resources.