04 Feb More value in a bear market but…

Are share options an incentive in the current market?
South Africa has experienced equity markets that have shown little growth for a number of years. Accepted wisdom is however that the role of management in profit orientated businesses is to increase shareholder wealth. This is most commonly associated with an increase in the company’s share price. However, in the current market a company’s share price can remain flat or even decline despite the fact that management is doing an excellent job in improving the performance of the business.

How should the value of share options be determined?
Typically share options form part of an incentivisation plan that should be made up of salary, short-term bonuses and long-term incentives (the latter being the share options). Although many of these options are cash-settled (and there are good reasons for this), should the value of the options be determined by the price at which the company is trading on the exchange or are there other techniques that can be employed?

There are many methods to incentivise management that pay no regard to the company’s share price. These are however usually used to determine the quantum of bonus payments (medium-term incentives) and not long-term incentives.

Market cycles typically not aligned to the term of employment
It is difficult to find good reasons why part of management’s incentivisation should not be based on the performance of the company’s share price, no matter what the market conditions are. The market value of the company’s share is what shareholders have to live with, so why should management be treated any differently? If markets are efficient over the medium to long term, management should be rewarded for their efforts. That is assuming the market regards them as having improved the value of the company. The problem is that market cycles are typically not aligned with the term of management’s employment with the company.

More value in a bear market but…
The truth is that the creation of value through share options has never been a certainty. The timing of some managers is good and they are offered shares ahead of a bull market, while others are offered shares at the top of the same market.  What one can say is that in a bull market share-based incentives are likely to offer management more value than in a bear market. His however doesn’t mean that share options should be disregarded as an incentivisation tool in bear markets.

Contact Mettle to assist you in designing a share incentive plan.

William Marais
27 21 929 4884
wmarais@mettle.net
https://mettle.net/businesses/corporate-and-specialised-finance
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