Options packages under fire

In little over a week, Niagara Mining Ltd shareholders will sit down to vote on whether to agree to a generous options package for their new recruit, Andrew Forrest.

Mr Forrest’s decision to join Niagara as non-executive chairman sent the nickel minnow’s share price roaring and with it the value of his option package.

According to an independent experts report, the value of Mr Forrest’s option package stood at $41.8 million on April 3, when Niagara’s shares traded at 24 cents.

The company revealed Mr Forrest would join the board on April 4 and would be granted 115 million options with vesting conditions ranging between 60 cents and $1.

On May 17 - the day after Fortescue Metals Group Ltd signed a nickel marketing agreement with Niagara - the company’s share price hit $1.48 and, according to an independent expert report, the value of Mr Forrest’s Niagara options stood at $316 million.

It’s a handsome windfall that has thrown this type of remuneration back in the spotlight.

Given recent examples, an executive looking for easy riches should approach companies without a big institutional base because it seems options packages are increasingly on the nose with the institutions.

Nickel producer Sally Malay Mining Ltd is one of the more recent cases of a company that elected to ditch its incentive options for executives after a share price spike put the options in the money and subsequently put it out of favour with the institutions.

Sally Malay managing director Peter Harold said that when the company prepared its options package, the options were not “in-the-money”.

However, the company’s shares subsequently enjoyed a solid kick after a spike in the nickel price, and suddenly the options package looked like a handsome pay-out for the company’s executives.

Mr Harold said that was never the intention, and when he learnt the institutional investors would vote against granting options to executives he cancelled the meeting.

Mr Harold is now working with a big accounting firm to devise a better way of providing incentives for the company’s executives.

“We had a significant reaction against issuing options,” he said.

“A lot of people are doing different structures now and our view is that we don’t want to be doing the wrong thing so we will work on alternatives,” he said.

He said it was a difficult area and “the corporate governance rules don’t give you any help”.

Mr Harold said the institutional investors took issue with granting options to non-executive directors.

“The current guidance is that non-executive directors are out all together,” he said.

He said potential alternatives to provide incentives for management could be zero priced options and share purchase schemes.

Australian Shareholders Association WA chairman Tom Herzfeld said his association was opposed to companies granting options to non-executive directors, but was comfortable with issuing options to executive staff if the incentive package was reasonable.

“We believe that the managing director should hold an interest in the company through a stock holding so their interest is aligned with shareholders,” Mr Herzfeld said.

“But the incentives have to be real, it shouldn’t be granting one million options at 20 cents when the company is likely to reach that target within a few months. There has to be reasonable hurdles and they shouldn’t be getting options for doing an average job.”

Former Alinta Ltd CEO Bob Browning was one notable victim of shareholder frugality three years ago when an options package was withdrawn following pressure from institutional investors.

The package - 200,000 options with a strike price of about $5.90 a share split into three equal tranches over three years - came after Alinta made its second major acquisition in two years and corresponded with a rise in publicity about shareholder concerns over executive remuneration.

Mr Browning believes options packaged properly are the best way to align managers with shareholders.

“They are the most effective way to tie executive wealth generation and shareholder wealth generation,” he said.

Mr Browning said there needed to be a balance regarding the number and strike price, but overall he believed many investors simply didn’t understand how options worked.

“It's not a cash bonus. I think what is missing is more effective education in the marketplace about how it works.”

The Niagara board are doing their best to educate their shareholders of the benefits of securing Mr Forrest.

In a letter to shareholders, Niagara acknowledged that the conditions placed on Mr Forrest’s options would likely be met five consecutive business days after the options were issued.

But it said the purpose of the options was to “provide an incentive to Mr Forrest to assist in the achievement of the company’s objectives…and to align his interests with shareholders”.

The company said that in the event the options were exercised, the “incentive remains to contribute to the achievement of the company’s objectives, derive shareholder return and increase the price of a share”.