30/11/2011 - 11:14

Option valuations can mislead

30/11/2011 - 11:14


Save articles for future reference.

Remuneration reports are deeply flawed but with some redesign could deliver much more useful information to shareholders.

Remuneration reports are deeply flawed but with some redesign could deliver much more useful information to shareholders.

FOR the past 10 years, WA Business News has completed a detailed annual survey of executive remuneration.

Over that time, the perennial issue has been whether chief executives get paid too much.

This year’s 12-page survey attempts to answer that question by dissecting the data and looking in detail at the pay and performance of selected Western Australian companies.

In order to do that we have drawn selectively from the data published in remuneration reports.

The raw data in these reports – which ASX-listed companies are required to publish – can be highly misleading, principally because of the inclusion of equity incentives, such as share options.

As a result, every year the official data tell us that the chief executive of an obscure mining company is among the most highly paid business people in the state.

This year, for instance, Elemental Minerals directors John Macpherson and John Sanders had total remuneration of $3.63 million.

That put them up on a par with Iluka Resources’ David Robb and Bunnings boss John Gillam.

The problem is that nearly all of their remuneration ($3.37 million to be precise) was courtesy of share options.

Their cash income was a relatively modest $259,000 – a fraction of Mr Robb’s cash income.

This is not a one-off; it happens every year.

In 2010, it was the turn of Indago Resources’ Tim Kestell and Peter Pynes, who were awarded share options worth $4.8 million.

In 2009, it was Australasian Resources managing director Andy Caruso, whose options were valued at $2.2 million.

That was the same year Rio Tinto Iron Ore boss Sam Walsh had a total income of just $152,000, according to the company’s remuneration report.

How does that figure, especially when he had a base salary of $1.38 million? The answer lies in the arcane world of equity scheme valuations.

In 2009, the value of Mr Walsh’s interest in Rio’s executive equity scheme went backwards, presumably reflecting falling share prices and the dismal outlook at the time.

This was recorded as negative income. Imagine if the ‘deduction’ outweighed his other income, and he was left with a negative figure.

Anyone who has dealt with share options knows that their valuation is a highly inexact science. The final value derived by the recipient may be a lot more, or in most cases a lot less, than the estimate included in the annual report.

A better guide to the value of share options is recorded every week in this newspaper, in the Directors Interests’ table (see page 29 this week).

It shows the actual trades (buying and selling) conducted by directors of WA-based ASX-listed companies.

This includes company directors who have exercised share options, often turning an instant profit.

The examples in this week’s edition are Quickflix directors Stephen Langsford and Simon Hodge.

They were able to buy shares at 50 cents, compared with a prevailing market price of 76 cents per share. A modest profit, but a guaranteed profit nonetheless.

Readers of last week’s edition would be familiar with our report on a couple of much more striking examples.

Atlas Iron managing director David Flanagan exercised some of his options to buy 2.5 million shares at 72 cents per share (total cost of $1.8 million). On the same day, he sold the same number of shares at the prevailing market price of $3.11 (total proceeds of $7.7 million).

After the back-to-back deals, he retained the same interest in Atlas (2.7 million shares) but also had an extra $5.9 million in his pocket.

I certainly don’t begrudge Mr Flanagan this gain. Atlas is one of the great success stories of the current resources boom, and Mr Flanagan’s leadership has played a big part in the company’s emergence as a profitable iron ore miner. 

It also compensates for the years when Mr Flanagan earned a modest cash income, which is exactly what share options are designed for.

I also believe this information is far more interesting, and far more useful than the valuations that appear in remuneration reports.

A second example reported last week was that of Atlas Iron director David Hannon. He bought 500,000 shares at 70 cents and sold 800,000 at $3.11 – a very tidy back-to-back trade indeed.

Wouldn’t it be useful if this information were collated in remuneration reports each year?


Subscription Options