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Share options lose as talent honey-traps

JACK Welch, the former Chief Executive of General Electric (GE) had a very straight-forward talent management philosophy. Every year the bottom 10% performers in GE had to leave.  I do not agree with this method. However, the subtext of Jack’s method is that retention is not always desirable.

The problem of the “big men” of Africa shows the harm retention can do.  Retention needs to be balanced with renewal, seems to be the message here.

Opinion is divided over the need to tie the chief executive (CE) in the company for long. The traditional view is to do whatever it takes to keep the high-flying executive. The renewal school is challenging this view. The renewal school argues that five years is the average period within which a CE adds value. It is posited that after five years the CE becomes a net cost to the company. This view informs the growing practice of placing senior executives under an employment-cum-performance contract with a five-year lapse period. Seeing through the renewal lenses has a bearing on how senior executives are rewarded.

From a renewal viewing point, offering the CE pension is not seen as necessary. Instead, gratuity is offered as a percentage of the annual basic salary. This gratuity typically vests at the lapse of the contract period. It is possible for a senior executive to get a gratuity 1,5 times their annual salary at the end of the contract. Cost-wise, the organisation is free from post-employment costs.

Traditionalists are known to be in full support of offering share options and other long-term incentives to try and bind senior executives. Renewal proponents lament that boards just don’t get it. They strongly argue that money is not an effective retainer of top talent. 

Renewalists insist that premium talent hates being bound in one place for long. Sweetened offers are not very appealing enough to dissuade them from leaving, the logic goes. In my opinion two reasons account for this. The old adage, “you better leave the stage while the crowd is still longing rather than loathing” partly explains the nomadic tendencies.

Leaving at the height of organisational success when your stock is hot preserves credibility, keeping CV intact, and retaining employability, is a strategy used by many high-fliers. This strategy is akin to what is referred to as cannibalisation in strategic marketing, where popular models are unexpectedly withdrawn from the market to be replaced with newer models. Cumulative experience garnered from current employment allows high-fliers to repackage themselves as improved “models” to new employers. Winners know when to quit. Mandela knew when to quit. Michael Eisner, the first CE from outside the Disney lineage is credited with the re-invention and re-incarnation of Disney’s founding success. He did not know when to quit until a recent board ouster reminded him he had reached his sell-by date.

Second, according to the renewal school, for top talent to stay long, the organisational brand has to be very appealing. Smart employees do not want to spoil their CVs by being associated with organisations losing credibility.  Using intuition to sense what others cannot,  they jump the ship before it begins sinking.

Dr Mark Bussin, the Executive Chairman of 21st Century consultancy, a respected HR consultant, builds his renewal argument from the premise that ‘employees leave managers’. It is argued that long-serving executives begin to focus on value-destroying practices to protect their fiefdoms. One such self-preservation stratagem is frustrating high potential talent and probable successors out of the organisation. By so doing, the quality of the bench declines as quality bench players troop out of the organisation. Ironically, by retaining executives for too long, the organisation might find itself presiding over the loss of premium talent.   

One of the passionate advocates of the renewal philosophy is former CE of Gencor (now BHP Billiton) and former South Africa Minister of Finance, Derek Keys. Keys is of the opinion that a CE who leaves an organisation in good standing should not be penalised through forfeiting  shares allotted to them under a share-based retention scheme. Keys  argues that the departing CE forfeits future value from the future growth of shares. The value of the shares up to the date of departure is seen as rightfully theirs as they represent the value created by the CE up to that point.

Derek’s formula for retaining talent is represented by the famous 4Ls-live, learn, love, legacy. Interpreted, the employee is saying,  “for you to keep me long enough, pay well and fairly, allow me to grow, care for my social needs and give me space to leave a mark”. Here is the problem with the traditional view of retention. It focuses on paying well. Boards are generally guilty of taking a parochial view of retention, the throw-money-at-the-problem approach.

The short-comings of the monetarist approach to retention are currently being exposed by changing rules in accounting. Share options used to be the silver bullet favoured of boards to bind top talent. In a share option scheme a qualifying employee is offered an opportunity to buy shares in future at a fixed price. Let me illustrate the idea. For instance, one Econet share at the time of writing was valued at 461 cents. Econet could offer its key performers to buy the shares at 461cents each five years down the line. The idea is to motivate the employee to stay long and ensure that they contribute to the success of the company which causes the share price to grow. Let us assume the Econet share price doubles to 922 cents in five years time. An employee could buy the shares at the prior-promised price of 461cents per share and immediately re-sell at 922 cents per share.

Share options are fast losing their honey-trap qualities. International Financial Reporting Standard (IFRS2) governing the accounting of share-based schemes after 2005 demands immediate expensing of structured share option schemes. Prior, share options costs were expensed in the accounting books when the options were exercised.  Company profit was thus over-estimated, violating the time-honoured accounting principle of prudence. The tax advantages enjoyed prior to IFRS2 are disappearing.

At the time IFRS2 came into effect, Zimbabwe was still reeling under the weight of the debilitating hyper-inflationary environment, which made the impact of IFRS2 not to be felt. Now that we are using a stable currency, boards will soon discover that share options and other share-based retention schemes on their own are no longer very effective talent-binders. Institutional investors in some countries are tightening pre-conditions for awarding share options such as refusing to approve options with exercise prices below market value.

The message is simple. Do not overpay. Make your organisation a great place to work. Remember top talent is highly nomadic whether the economy is good or bad. Get as much as possible from your top talent while they are still with you. When they leave keep in touch with them and re-hire them where possible.    

More important, organisations need to avoid the creation of “big men” through over-staying. Performance and contract-based employment for senior executives is worthy considering.  
Should organisations  strive to hold on to long-serving executives? Feedback to brettchulu@consultant.com.

By Brett Chulu

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