Options make for opaque package value

UNDERSTANDING the growing complexity of remuneration packages is a challenging exercise for investors seeking to determine the value, or otherwise, offered by a company’s management team.

In particular, the use of share options, performance rights and other equity instruments makes it very difficult to work out just how much some chief executives are paid.

The real value of these equity instruments only becomes clear when company directors exercise their options or convert performance rights into ordinary shares.

That can deliver multi-million dollar benefits, as shown in the table, yet in most cases these windfall gains will never appear in a remuneration report.

Some companies have responded to the complexity surrounding remuneration by publishing two sets of data in their annual report.

Their fulsome disclosure is admirable but it’s unclear whether investors are any the wiser.

Take Iluka Resources, for example. On page 31 of its annual report, it publishes ‘short-term employee benefits’. For managing director David Robb, the total comes to $5.3 million.

On page 17, it publishes ‘total earnings’; for Mr Robb, that number is slightly lower, at $5.1 million.

But total earnings isn’t, actually, total earnings.

“The table does not include share-based payments which reflect the accounting value of share rights granted in the current and prior years which may or may not be realised as they are dependent on the achievement of performance hurdles,” the company stated.

For further insight, if that’s the correct term, go to page 29, where the company discloses the fair value of share rights granted in 2011; for Mr Robb that amounted to $9.1 million.

So depending on how accounting rules are interpreted, Mr Robb’s total remuneration in 2011 could be as high as $14.2 million.

And for even more data, Iluka shareholders can go to page 33 of the annual report, where the company discloses the “maximum value of unvested restricted shares and share rights”; for Mr Robb, that was a further $8.4 million.

The variation between different disclosure types is even more extreme in other cases, such as Iluka’s chief cinancial officer Alan Tate.

His ‘short-term’ benefit amounted to $1.05 million, including a base salary of $588,000 and annual bonus of $443,000.

But his ‘total earnings’ were $3.16 million, after adding in share-based payments under the company’s long-term incentive scheme and staff retention plan.

Lack of clarity

Similar issues arise at Macmahon Holdings, where the accounting rules do not deliver a clear picture for investors.

In Macmahon’s 2012 annual report, under the discussion of CEO remuneration, it states on page 64 that 4.92 million Class A performance rights valued at $2.73 million vested on July 1 2011.

Yet on page 70 it states that the total value of ‘shares and rights’ paid in 2011-12 to then CEO Nick Bowen was just $646,490.

Crucially, this is the figure used to calculate Mr Bowen’s total remuneration, of $1.24 million.

The company explained to II'. 1 Business News that the $646,490 figure “is an accounting concept rather than any amount paid to Mr Bowen in the course of the financial year”.

This figure is determined by the ‘share-based payments’ accounting standard, which requires any performance rights to be valued at the time of issue and expensed over the vesting period, irrespective of whether the CEO subsequently meets all of the conditions of vesting.

In other words, $646,490 represents the portion of the ‘book’ expense required under the accounting standard and does not represent actual shares granted to Mr Bowen in the period.

“The reference to shares vesting on page 64 is the true value of shares which Mr Bowen became entitled to, once vesting conditions were met during the period,” the company said.

And what value did Mr Bowen finally realise from the performance rights?

They were converted to ordinary shares in August 2011, when the stock was trading at about 62 cents, valuing them at $3 million.

Since then, the stock has traded as high as 85 cents but is currently about 27 cents, which just shows how wildly the value of all equity instruments can swing.

Two tables

Paladin Energy is another company that presents two different remuneration tables in its annual report.

For managing director John Borshoff, the total is about the same in each ($3.5 million) though the components are very different.

Much more interesting is the case of company secretary Gillian Swaby. The “cash value of earnings realised” was $801,000 but after adding in share-based payments, Ms Swaby’s total compensation jumped to $1.9 million.

Reported value

Northern Star Resources is a prime example of how the reported value of share options can end up being very different from the actual value ultimately derived.

This cuts both ways; in some cases, share options with a high reported value end up being worthless because the share price collapses.

Northern Star is the opposite; its share price has soared from 1 cent to $1.50 over the past three years.

Over that time, managing director Bill Beament has been awarded share options with a total valuation of $259,000, according to the company’s annual reports.

Yet in August this year he reaped an instant paper profit when he converted 6.5 million 10-cent incentive options into 5.8 million shares. (The balance was held in an employee share trust to enable cashless exercise of the options.)

The shares were worth 96.5 cents at the time, delivering a paper profit of $5.04 million.

Just last week Mr Beament sold 8.2 million shares at $1.35 per share, giving him an even larger gain on the incentive options.

There is no suggestion this is inappropriate or unwarranted. Mr Beament has led the company during a period of outstanding success, and all shareholders are better off.

But it does mean the disclosure in the remuneration report does not tell the full story.

Northern Star chairman Christopher Rowe and non-executive director Michael Fotios have also reaped handsome rewards from their incentive options.