Long-term incentives are a tool to attract and retain talent

LTIs come in various different forms, but usually fall within one of three categories:

Market value-based LTIs

These are either restricted shares or stock units which confer commitments or entitlements to receive shares or cash in the future under certain conditions, or “phantom shares” which are virtual shares that give the holder the right to future cash out in the amount of the valid share price of the company. Unlike share options, phantom shares do not only contain the increase in value, but the entire share value as return. Since only fictitious shares are issued, this method can be suitable for unlisted companies.

Option-based LTIs

Option-based LTIs can be structured as stock options or stock appreciation rights. While stock options grant the holder the right to buy shares at a fixed price – the exercise price – on or up to a certain date after expiry of a waiting period, stock appreciation rights are virtual stock options. The financial benefit that an employee would receive by purchasing shares in stock options is paid out in cash.

Performance-based LTIs

This form of LTI can grant employees a performance cash plan, which awards a bonus linked to the long-term company success. At the end of a fixed term, usually at least three years, the amount of the cash payment is determined based on predefined performance targets – whether an internal target, such as return on capital expenditure, or an external target, such as share price. Alongside the structuring of a cash plan is the performance share, which grants employees shares of the company free of charge according to pre-defined performance targets. The term also usually lasts at least three years.

Stock option plans

The most commonly used LTI is a stock option. Where employers are exploring granting stock options, they should consider a number of issues.

Legal basis

An agreement on the granting of stock options made between an employer, or an affiliated company on its behalf, and employee is, in principle, part of the employment contract. However, for stock option plans there are some specific regulations to be considered.

If an employee is rewarded with a stock option of the parent company or a group company of the employer, only the respective company that issued the stock may be obligated towards the options. In the case that only the parent or group company is obligated towards the employee, the obligations do not pass to the acquirer of the business in the event of the sale of the business because no claims under the option plan existed against the employer prior to the transfer of the business.

In general, two models: either the employer acts as the contracting party of an LTI, or another group company. The legal differences can be quite significant. If an LTI stands independent from the employment contract, it might not be subject to German employment law, which can be an advantage in case of legal disputes. However, to disconnect an LTI from the contractual entitlements towards the employer, it is essential to make this distinction very clear and transparent to the employee from the very beginning.

Principle of equal treatment

The employer must keep the principle of equal treatment regarding labour law in mind. This states that the employer must treat employees or employee groups that are in a comparable situation equally, when applying a self-imposed rule. The principle of equal treatment under labour law not only prohibits the arbitrary discrimination of individual employees within a group, but also the formation of groups without any objective purpose. If the employer decides to only grant share options to certain groups, these groups must be distinguishable from those who are not entitled to obtain share options.

Commitment and expiry clauses

For the event of termination of the employment contract, share option plans usually contain expiry and leaver clauses. These clauses can govern a loss of rights from the original agreement, an obligation to reimburse the shares acquired, or even an obligation to pay back any profits made. The consequence depends on the time of the termination of the employment – where the employment is terminated while the employee is still in the waiting period for stock options, the employee loses the rights from his stock option plan, whilst a termination after the employee has already received stock usually leads to the obligation to return the stock.

The German Federal Labour Court generally considers such clauses admissible due to the speculative nature of stock options. However, there are strict legal limits under German employment law. Therefore, it can be worth considering whether LTIs can be disconnected from the German employment contract.

Co-determination rights of the works council

As LTIs are voluntary benefits, the works council does not have any general co-determination rights regarding their implementation. However, they can have rights regarding the distribution frameworks and conditions if an LTI is offered directly by the employer. If LTIs are issued by a foreign group company, the German employer will usually not have any scope for designing the conditions and, as a result, the works council cannot co-determine the LTI conditions effectively.

In Spain, as in Germany, LTIs can be classified as either market value-based LTIs, option-based LTIs, or performance-based LTIs. The most widely used LTIs in Spain are stock options. However, because giving employees access to share capital can lead to future conflicts and run against the interests of the founding shareholders, phantom shares are currently popular in Spain as an alternative solution.

Stock option plans

Legal basis

Stock options, which are not regulated as such under Spanish legislation, are a tool for remunerating employees where the employer offers the employee its own shares or those of its group at a previously determined price, with the expectation that at the time the option is exercised the sale price on the stock market will be higher. This allows the employee to obtain a profit on the transaction, consisting of the differential between the initial valuation price and the price finally obtained.

Normally the option plan is set at one date and exercised at a different date, usually at intervals of more than one year.

A common form of stock options is to offer employees of subsidiary companies shares of the international parent company.

Phases

In Spain, when an employer decides that they want to issue stock options, there are three phases to consider:

• Establishment of the stock option plan: the legal instrument by which the stock option plan is created and assigned and determines its legal regime;
• Maturity of the plan: this is the period established between the recognition of the plan and its effective implementation – it is usually over multiple years, although some plans have an annual maturity. The purpose of the maturation period is twofold: first, it serves to commit employees to the company over the period in order to enable those employees to be able to exercise their option during the execution period); and secondly, it incentives employees’ performance over the period since they stand to benefit financially the more the company’s market valuation rises.
• Execution of the plan: the moment at which the plan becomes effective, i.e. when the employee can acquire the shares at the pre-set price to incorporate them into their assets or sell them if interested.

Contract termination

Stock options are a right conditional on remaining with the company at the date of exercise. Problems arise when the termination of the contract occurs in the middle of the plan's maturation process and before its expiry.

Firstly, the specific stock option plan must be followed. In the absence of any provision, a distinction is made between two different scenarios:

• If the termination occurs for reasons attributable to the employee, such as they take voluntary redundancy or are fairly dismissed, the employee has no right at all to the option, not even to a proportional part.
• If the termination is for reasons attributable to the employer, such as the employee has been dismissed for objective reasons or their dismissal has been unfair, case law has held that the employee cannot be prejudiced and that, therefore, they may exercise the option when the time comes for it to expire.

Profit allocation

Stock options remunerate the entire period from the date of grant to the date of exercise. The profit obtained when the options are exercised corresponds to the whole period between these dates, so the profit must be pro-rated over the months between the date of grant and the date of exercise.

Accordingly, only the pro-rated part, taking as a reference the period from the grant to the exercise, and which also corresponds to the last 12 months prior to the dismissal, is considered as computable salary for the purposes of calculating the severance payment.

Phantom shares

As in Germany, phantom shares issued in Spain are virtual shares which entitle the holder to receive cash in the future in the amount of the price of a valid share in the company.

With the delivery of shares to employees through stock options, not only are economic rights derived from profit participation granted, but so-called 'political rights' to the shares are also obtained. Political rights are those rights that guarantee participation in the management of the company, such as the right to attend general meetings, the right to vote on resolutions adopted, and the right to information. Therefore, the employer has to be clear whether they want the employee to have shares in the future that give them such rights, or whether offering a cash amount would alternatively motivate the employee in the long term. It is in this context that phantom shares are increasingly being used in Spain.

In Singapore, the most common types of long-term incentive plans for employees include are employee share option plans (ESOPs) and share award plans.

ESOPs are where employees are granted options to purchase shares in the company at a fixed exercise price. This may be at market value, or a discount to the market value. ESOPs are usually subject to a vesting schedule where the employee must attain certain time-based or performance-based conditions before the shares are vested.

Share award plans are plans where employees are granted shares at no cost. These are usually subject to a vesting schedule where the employee must attain certain conditions before the shares are vested.

ESOPs and share award plans are usually offered by companies publicly listed on the Singapore stock exchange to executive directors and key employees to encourage loyalty as well as for employees to feel motivated to work in line with the company’s best interests. Employees may also be offered these plans by private companies, such as startups and companies in the early-growth stage, as it allows companies to attract, motivate and retain staff despite lacking capital.

In Singapore, it is not uncommon for the employees to participate in share plans where the shares on offer are not shares in their employing entity but rather in another entity within the corporate group, such as a parent company.

Regulations

There is currently no law in Singapore which directly regulates employee incentive plans. However, there are certain other regulations which employers should take into consideration when designing an incentive plan.

• Under the Employment Act 1968 of Singapore, employees who participate in employee incentive plans may choose to have their salaries deducted to pay the exercise price of vested share options. This is permitted so long as the employee has provided written consent to the deduction, and the deductions are no more than 50% of the individual’s salary in any one salary period;
• Under the Securities and Futures Act 2001 of Singapore (SFA), every offer of securities or securities-based derivatives contracts in Singapore must be made in or accompanied by a prospectus or profile statement, which must be registered by the Monetary Authority of Singapore, unless otherwise exempted by provisions in the SFA. One exemption is that under certain conditions being met under the SFA, the offer of ESOPs or share awards will not require a prospectus if the recipient of the offer is an employee or former employee and holds shares of the entity or its related corporation either directly or through a trust.
• Under the Companies Act 1967 of Singapore, private companies are permitted to have a maximum of 50 shareholders, and exceeding this number would require the company to go public. The cap excludes employees or former employees from the company as well as its subsidiaries. In general, public companies are subject to more regulation and control, particularly if the public company is listed on a stock exchange and has to also comply with the relevant listing rules of the relevant stock exchange as well.
• Under the Personal Data Protection Act 2012 of Singapore, an organisation must generally obtain consent from data subjects before there is any collection, use or disclosure of personal data, unless a certain exemption applies. Provided that an employee is informed of the purpose of the collection, use or disclosure of his personal data, the express consent of an employee is not required if the data is used reasonably for the purpose of entering into, managing or terminating the employment relationship.

Leaver events

If an employee decides to leave the company whilst holding unvested or unexercised incentives, the company will have to decide how they wish to deal with the unvested or unexercised incentives. The decision could vary based on the circumstances under which the employee leaves the company. For example, employees who leave under amicable circumstances may be allowed by the company to exercise any unvested or unexercised incentives. On the flip side, if employees leave under bad circumstances – such as where they have been dismissed, there has been breach of restrictive covenants after termination, or breach of confidentiality – the company may prevent the employee from exercising their incentives accordingly.

The situation in the UK in terms of the types of LTIs available is similar to that in Germany. However, there are a number of tax advantaged share plans in the UK which offer significant tax savings for employees. These include:

• Discretionary plans where awards can be granted to any eligible employees – Enterprise Management Incentives and Company Share Option Plans; and
• All-employee plans where participation must be offered to all eligible employees – Save-as-you-Earn Plans and Share Incentive Plans.