Share Sleuth: Be wary of excessive executive pay

Events at Tristel are a reminder that complicated remuneration schemes masking inflated executive pay extend way beyond the big companies and ‘fat cats’ that make it into the headlines. Boards showing restraint, in my opinion, are exceptions, even among smaller companies.

I pick on Tristel (which makes hospital disinfectants) for three reasons. It is topical, it plans to implement my least favourite method of performance-related pay, and it has been good enough to put the plan to the vote. Tristel’s directors will ask shareholders to approve a new performance share plan at the firm’s annual general meeting in December.

Under the plan, Paul Swinney, the company’s founding chief executive, and Liz Dixon, its finance director, will receive options on up to 500,000 and 400,000 shares respectively, as long as the average share price exceeds certain levels for a period of at least three months before June 2021. The full award comes into play if the share price rises from its current level of around 280p to 500p.

A share option gives the holder the right to buy shares at a fixed price, in this case one penny. At the 500p target, Swinney would have to pay £5,000 (500,000 shares times £0.01) to turn his options into shares worth £2.5 million (500,000 shares times £5.00). Under the terms of the agreement, he wouldn’t be allowed to sell the shares until June 2021, by which time they could be worth more or less. Either way, the two executives could receive quite a windfall.

Two questions. Does this plan really reward performance? And are the executives worth it? I think the plan is very loosely tied to performance, and that the potential payout is only justifiable in the context of excessive executive pay in general.

-Global dividend payments surged by 14.5 per cent in Q3 of 2017

Over the long term, share prices depend on a firm’s performance, but they’re much more volatile. Share prices soar when traders expect companies to do well in the immediate future, and collapse when they fear imminent trouble.

Thus Tristel’s price collapsed earlier this decade as it was driven out of the market for machine disinfectants, even though it had developed a unique and popular range of disinfectants for outpatient departments that could be applied to medical instruments by hand. Its share price has rebounded exuberantly as the new products have proven to be even more profitable than the old ones. But the hard, innovative work Tristel did during the turnaround would not have been rewarded by an incentive scheme such as the one the firm proposes, even though it was the basis for today’s prosperity.

I would expect a company serious about incentives to choose measures more consistent with its business plan. The targets for the business require it to increase revenue by an average of 10-15 per cent a year for three years, for example, and to maintain adjusted operating profit margins above 17.5 per cent.

The most insidious aspect of a share price target is the potential for managers to influence traders’ expectations, and therefore the share price. The 500p target puts the idea in traders’ heads that such a level is attainable. To an extent, companies choose what information they share, how they present it and what they withhold. These choices affect perceptions, and consequently the share price.

If Tristel achieves its target share price for three months but the price then subsides for years after because the company fails to perform as well as expected, its executives will have bagged their shares, but shareholders will still be waiting for the performance.

Swinney and Dixon have negotiated a tricky transition into prosperity. Their efforts deserve recognition, and the company should secure their services for the future. As with so many companies, it’s the complexity and quantum of the rewards Tristel proposes that I question.

At a price of £5, the 900,000 shares going to the pair would be worth £4.5 million. That’s more than Tristel earned in profit in 2017, a record year. It’s twice what Tristel earned in profit in 2016. Shareholders turn a blind eye because of the complexity, and because if the share price rises ‘everyone’s a winner’. But if shareholders don’t keep executive pay in check, it will keep spiralling ever higher. 

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