How effective are incentives for executives?

There is no doubt remuneration and incentive-based packages attract and retain the best talent and underpin a company's performance. However, in light of the global financial crisis, underlying incentive models are somewhat ineffective, in driving the desired behaviours, says PwC.

The underlying model aims to drive shareholder value through greater alignment of managers' behaviour with the interests and expectations of the shareholder and relies heavily on the use of incentives. The model is based on the principle that a conflict exists between managers and shareholders and that the role of the incentive is to create a long-term view among managers and shape decision-making behaviour.

"However, if we look at these reward mixes where there is a fixed salary and a variable portion, you would find the variable portion relates to a company's and employees' performance and is based on complex models," says Karen Crous, associate director in Tax at PwC. "As changes in accounting policies and increased transparency requirements from shareholders influence remuneration models, current structures and models, which are difficult to understand and complex, detract from the common-sense perspective. "King III advocates transparency and simplicity, but current models operate counter intuitively to these guidelines," she explains.

We need a new model

Paul Shaw, manager in tax at PwC, adds: "The model must change to allow fairness and achieve a balance between employees and shareholders."

As a solution, both Shaw and Crous have a number of alternative models, one of which includes a significant increase in the employee's salary with a requirement to use the increase to purchase shares rather than receiving options. This long-term incentive is aligned to the objectives of shareholders and the employee. If equity markets suffer losses and impact shares, when economies recover and bulls enter the markets again, the employee's performance will be rewarded by the value of shares over a number of years.

A number of companies in the mining sector have adopted another model where a bonus is paid in shares and cash. The shares are vested for three years and the cash is received at the end of the financial year.

A third option

A third option is a bonus bank, where employees defer their bonus over a number of years into a bank, which they can subsequently claw back a bonus from. "If a company's strong financial performance over a number of years is followed by one year of losses, employees have the opportunity of ensuring they can still receive a bonus from the years where the company performed well. However, the criticism here is that the longer people wait to get their bonus, the more it gets diluted," explains Shaw.

"Even though the principles of King III advocate transparency and simplicity, it's not a one-size-fits-all approach. Remuneration committees need to be practical and offer models that make sense in their industry. The key is to understand that complexity and ambiguity destroy value," concludes Crous.