Date: February 4, 2005
Recently, Asia Pacific Breweries Limited (“APB”) announced that they would replace their Executives’ Share Option Scheme (“ESOS”) that had expired in July 2004 with a Phantom Share Option Plan (“PSOP”). APB explained that there was little difference between their ESOS and PSOP and noted in particular that the executives stood to have the same gain under the new scheme and nothing more. They also said that a PSOP avoided the dilution of shareholders’ interests which was a major objection raised by shareholders to share options. APB is the first company in Singapore to adopt a PSOP.
What are phantom share options? By way of illustration, an executive may be given an option pegged to 100,000 shares at the exercise price of say $3.00. If the share price has gone up to $5.50 at the time the option is exercised some years later, then the company gives the executive a cash payment of $250,000.
SIAS Position on Phantom Share Options
SIAS views the APB scheme as an alarming development and wishes to make it clear that we are strongly opposed to phantom share options as it is not in the interest of shareholders. With the expensing of stock options mandatory from 1 January 2005, many companies are considering alternatives to stock options and SIAS certainly would not want to see these companies migrating from conventional share options to phantom share options.
SIAS objects strongly to phantom share options for the following reasons:
Disconnect between Performance and Reward
First, we should state that we are generally against any remuneration where the reward comes mainly from share price appreciation – this includes conventional share options and phantom share options. This is because there is a great disconnect between the executive’s performance and reward. While some may argue that the share price would ultimately reflect a company’s performance, in reality we have all seen share prices that do not reflect a company’s good performance or bad results and this disparity can persist over a period of years. We have also seen markets going wildly bullish or unreasonably depressed, so that even a poorly performing company can enjoy a multifold increase in its share price. At the individual level, we find it inequitable for the reward to a manager in charge of one country or one product line to be boosted or pulled down based on the performance of all his colleagues. Therefore, giving an executive share options is like giving him lottery tickets instead of a cash bonus based on key performance indicators carefully set for him.
A common claim is that share options align the interests of the executives with shareholders. However with share options, executives only enjoy the upside and have no downside risk unlike shareholders. We would much prefer to see executives actually owning shares and then their interests would truly be aligned with shareholders.
Huge Potential Cost
Second, we are concerned about the huge potential cost of phantom share options. Unlike ESOS where the quantum of the share option expense is highly controversial, it is clear that with a PSOP, the final expense in the above illustration would be $250,000. In the case of APB, the maximum amount of phantom shares that can be granted over 10 years is 10% of the existing shares. Assuming they are granted evenly over the 10 years, this can amount to 2.5 million shares each year (although historically the amount granted has been less). The appreciation of APB shares over the next five years is anybody’s guess. If we look at historical figures, then we see a doubling of the share price over the past five years to $7.80 today. Even if we look at the broad market, we see the Strait Times Index dipping below 1,300 in 2001 and again in 2003 and rising back above 2,000, representing a gain of over 50%. If APB were to grant 2.5 million phantom shares and they appreciate 50%, then we are looking at a potential expense of $9.75 million a year or roughly $8 million after tax. This compares with APB’s net attributable profit of $103 million in FY 2004. Depending on the share price movement and the formula used for provisioning the expense, the expense charged to the Profit & Loss Statement in any given year may be greater or less.
If the share price appreciates 50%, a financially healthy company can probably sustain the cost of PSOP. Our concern is over share prices that appreciate in a very major way. Shares of some companies have jumped more than five-fold over the last 5 years. At this point, we should point out that many companies set the maximum amount of their ESOS at 15% rather than 10% of existing shares, and the total tenor at 10 years rather than 5 years, so the potential cost can be enormous. In future this cost will have to be reflected in the Profit & Loss Statement, whether for conventional share options or phantom share options, and may introduce great volatility to earnings. For some companies, the entire profit and more will be wiped out by the cost of share options. We emphasize that the cost of phantom share options is open-ended: it depends on the whims of the stock market and is outside the control of the company.
Third, we are very concerned about the cash payout required under PSOP. This is the critical difference between ESOS and PSOP. If the share price really shoots up, especially because the market is euphoric rather than because the company is really doing well, the company can land itself in great trouble.
We can look at the actual experience of companies in the past few years to see how much would have been paid out if the companies had PSOP instead of ESOS. With an ESOS, if a share price jumps five-fold from $0.20 to $1.00 and there are 10 million option shares granted for that year, the company would receive only $2 million from the issue of shares under the options instead of roughly $10 million under a private placement. The existing shareholders would suffer a dilution of their interests, but the company itself would not have a problem with cashflow. In fact, the $2 million coming in would improve its balance sheet. On the other hand, under a PSOP, the company would need to pay out $8 million in cash and this could severely strain its cash resources.
No Shareholder Approval Required
Finally, SIAS is concerned that PSOP does not require shareholder approval. ESOS needs the approval of shareholders at AGM or EGM because it involves the issue of new shares. In the case of PSOP, because there are no shares issued, a company could argue that PSOP is a form of cash remuneration and there is neither the need to seek shareholder approval for the scheme nor the need to even disclose the scheme and the phantom share options granted under it. Yet, as we have seen above, the consequences of a PSOP can be grave for a company and as such we believe shareholders should have the final say in the matter and set the appropriate controls for such a plan.
In summary, SIAS strongly opposes phantom share options because (1) as a rule, we are not in favour of any share price based remuneration, (2) the open-ended cost is outside the control of the company and can be enormous, (3) the final cost has to be met in the form of actual cash payment which can severely damage the finances of the company, and (4) there is no shareholder control over PSOP.
While SIAS is not in favour of conventional share options, we consider that phantom share options are even more undesirable from the standpoint of shareholders.
Mr David Gerald J.
President & CEO
Securities Investors Association (Singapore)