We were recently asked by a client on the full list of the London Stock Exchange to advise on the grant of options to NEDs, we look at why this is generally frowned upon and whether this is always correct irrespective of how the option is structured.
A survey published by the Quoted Companies Alliance on 15 February 2008 found, amongst other things, that:
- the average annual fee paid to a NED is between £28,000 and £29,000 with most earnings between £25,000 - £39,900;
- over 90% receive fees as an annual/ quarterly/ monthly fixed amount (as opposed to being paid an hourly rate or similar); and
- only 14% of respondents (most of whom are NEDs of AIM companies) say they receive remuneration in the form of share options.
Section A.3.1 of the Combined Code makes it clear that a NED's independence may be impaired if he or she receives share options or is paid a bonus based on performance.
The Guidelines of the Association of British Insurers state that "remuneration for non-executive directors should not include share options" and goes on to provide that where, exceptionally, such options are granted:
- shareholder approval should be obtained for the grant; and
- the NED should be required to hold the shares acquired on the exercise of options until at least one year after he leaves the board.
The ABI accept that payment by way of shares in lieu of fees (as opposed to options) is acceptable, so what's the difference?
The conventional answer is that a NED has less to lose if he holds shares whereas if he holds an option which is structured so that it lapses on him ceasing to be a director before becoming exercisable, he may (potentially) have a great deal to lose thereby compromising his independence.
Our client was rather surprised by this attitude because they were proposing to grant options which vest monthly over one year and would lapse only to the extent unvested if the NED leaves in that period. What, you might ask, is the difference between that and paying your NED in shares in lieu of an annual or monthly fees?
Our client was unconcerned about the ABI's views as the majority of its institutional investors are US based (where the attitude to NEDs holding options is very different to the UK).
In our view the rules of the UK Listing Authority allow option grants to NEDs (if structured so performance and / or service is not measured over more than a year) without requiring shareholder approval. The options cannot be discounted and must be sourced by the direct issue of new shares but these do not count towards the dilution limits in the company's employee share plans as NEDs are not employees. There are FSMA and other issues which we can advise on if you are interested.