It’s been a tough couple of years for business following the outbreak of COVID-19. Most economists now agree that an economic downturn fuelled by geo-political events, rising interest rates and inflationary pressures is on the horizon.

So, what does this mean for employers with LTIP arrangements who are already faced with talent retention challenges? Thalia O’Toole, Tax Principal in our People Services practice, investigates how businesses can balance costs and maintain employee reward.

LTIP value in a downturn

While the impact of a downturn will vary between sectors, we would expect affected companies to see a decline in financial returns and a potential decline in share value. One or both can impact the value proposition of an LTIP for senior executives and the wider employee group e.g., financial metrics linked to pre-downturn growth expectations may no longer be appropriate making it difficult for awards to vest. This can impact employee motivation and retention. 

LTIP actions

While stock options remain a feature of many LTIPs, we increasingly see restricted stock units, discounted shares and restricted or forfeitable stock in equity arrangements. A look back at the 2008 global recession saw some of the following LTIP actions taken by employers:

  • Resetting of performance conditions e.g., change to TSR or other metrics
  • Deferral or reduction of LTIP awards to align with business conditions
  • Granting new awards based upon current and revised future market conditions
  • Exchange of options to counter underwater pricing 

Changes to LTIP arrangements

The appropriateness of any changes to an LTIP in the current climate will be linked to the type of plan, how affected the business is or could be, the likely length of any downturn and the impact of any changes on key employees.

Change to an LTIP arrangement is not a quick fix and there will be accounting, legal and tax implications for both the company and the participant that need to be assessed. Participant consent, and where a listed company, shareholder approvals, are generally needed.

Some LTIP arrangements may already provide for “malus” i.e., the ability to automatically alter awards in certain instances linked to employee or business performance – this is particularly seen in the financial services sector. Other schemes may just include a general clause which allows the company to amend or terminate the plan, subject to employee agreement. Regardless of the type of equity arrangement, employers need to first understand their scheme rules as part of any assessment of actions. 

Scheme rules

Let’s assume a typical market value option plan with a general amendment clause. Options granted at a time of stock market highs a couple of years ago could be well underwater. Firstly, the company will need to assess the likelihood of a price recovery in the short to medium term. Where price recovery is genuinely unlikely, not only is this a loss of an incentive for the employee, but there also remains an impact on financial statements over its vesting period. 

Exchanging new options for old would seem obvious to consider – new options of equivalent value in principle restores the incentive value for the employee although they would need to formally sign up to the change. It does however mean the company must hold a higher number of shares to meet its commitments in the future which can impact share dilution and overhang. There may be fair value adjustments in the financial statements to consider – the changing price and possibly new vesting period will impact here. The corporate and personal tax reporting would need to be confirmed. Demonstrating the business rationale to shareholders to secure approval is the final step in some cases before implementation.

Of course, that is just one example. Different considerations may arise depending upon the equity arrangement and proposed adjustments. Either way, there is a lot to consider before the button is pushed on any LTIP adjustment. 

Incentivising employees

LTIPs are a key incentivisation tool for employers. At the heart of any change should be the continued alignment of business and personal performance with reward. Balancing costs in a declining market while maintaining employee incentivisation is tricky. Being able to show employees that any proposed changes are in their interests and commensurate with the business climate and that a fair process has been followed should support talent retention and ultimately serve the business well.

Are we at this stage yet ? For some yes, for many, a “wait and see” approach makes sense in the short term. “Hope for the best, prepare for the worst” seems a good motto right now. No harm to dust off your LTIP arrangements and consider next steps. 

This article was originally written for the Irish Pro-Share Association (IPSA) Council and is reproduced here with their kind permission.

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