Executives of South African listed companies are increasingly incentivised using share-based remuneration. However, the valuation of share-based remuneration is complex and disclosure thereof in annual reports is often inconsistent – providing an opaque picture of what executives realise from such remuneration
Globally, executive remuneration has become a topic of interest to shareholders, regulators, and even the general public. The media often criticises excessive executive remuneration and the poor link between executive remuneration and the financial performance of companies – issues that were accentuated by the global financial crisis of 2007–2009. In South Africa, these issues have come under sharp scrutiny in view of the extreme income inequality between executives and other employees. Full disclosure of the remuneration earned by executives of South African listed companies is therefore crucial to ensure accountability and to allow essential monitoring by stakeholders.
Specifically, there is one crucial component of executive remuneration that does not receive its fair share of attention, namely share-based remuneration. Instruments such as share options and performance shares are increasingly employed in a bid to align the financial interests of executives and shareholders. However, the value that South African executives earn from share-based remuneration has historically been difficult to comprehend owing to inconsistent disclosures in annual reports.
In the United States and Western Europe the majority of executive remuneration value is attributable to share-based remuneration. By 2014, share-based remuneration, if measured at grant date fair value, comprised 62% of US executive remuneration and if measured at value realised on exercise date, comprised 81%.1 In Western Europe, by 2015, 51% of executive remuneration was attributable to share-based pay (measured at value realised).2 The observed substantial difference between the grant date fair value and the value realised on exercise date emphasises the need to disclose the realised value accurately – as realised value represents the actual remuneration earned.
Disclosure requirements in South Africa
The previous Companies Act (61 of 1973) required companies to disclose the ‘gains made on the exercise of share options, the gain being the difference between the price paid for the shares and the market price of the shares on the date of exercise’. After the effective date of King II in March 2002, listed companies were required to disclose this gain on a per-executive basis.3
The new Companies Act (71 of 2008), effective from 1 May 2011, requires that companies disclose per executive ‘the value of any option or right given directly or indirectly to a director’. Thus, the new Companies Act has extended the requirement of the previous Companies Act: all share-based remuneration needs to be included in the disclosures, not just share options. However, the new Companies Act is not clear regarding how and when the value should be calculated. Subsequent to the effective date of the new Companies Act, companies have been disclosing the value associated with executive share-based remuneration inconsistently: some disclose the fair value of share-based remuneration granted during the year, while others disclose the value realised from share-based remuneration during the year and yet others even disclose the IFRS 2 expense on a per-executive basis.
King IV (effective from 1 April 2017) explicitly requires per-executive disclosure of the fair value of share-based remuneration received or receivable during the reporting period; fair value at grant date and reporting date of unvested awards; and cash value of share-based remuneration settled during the reporting period. Thus, the value realised from share-based remuneration is a required disclosure under King IV (referred to as ‘cash settlement value’). If King IV’s requirements are complied with, the comprehensive disclosures should enable appropriate monitoring of executive share-based remuneration.
The value captured by the IRESS financial database
Executive remuneration of companies listed on the Johannesburg Stock Exchange (JSE) is captured by commercial financial databases, with the IRESS financial database often being used by researchers and practitioners. The IRESS database captures the per-executive remuneration earned from annual report disclosures. The data categories in the IRESS database include the guaranteed package, bonuses and ‘gain on shares’. The line item called ‘gain on shares’, which has been reported from 2002 onwards, was probably designed to capture the value realised from the exercise of share options (as required by the previous Companies Act read together with King II) and is the only data item captured that relates to the exercise of share-based incentives.
However, Steenkamp and Wesson,4 when studying a sample of JSE-listed companies for the period 2002–2015, found the ‘gain on shares’ line item to be significantly understated on the IRESS database, especially after the effective date of the new Companies Act. The understatement might result from both the complexity of share-based remuneration arrangements (making it difficult for data capturers to identify accurately the value realised) and inconsistent disclosure practices (sometimes the value realised is not explicitly disclosed but can be calculated from annual report disclosures). The actual value realised (when using the annual reports as source) was between 200% and 250% of the ‘gain on shares’ amount reported by IRESS when considering the period 2011−2015.5
Value of share-based remuneration earned by executives of JSE-listed companies
Does share-based remuneration earned by executives of JSE-listed companies represent a substantial portion of total executive remuneration (as in the US and Western Europe)? As explained, the ‘gain on shares’ line in IRESS purports to measure the value realised from share-based remuneration by South African executives. However, this value may have been substantially underreported since the effective date of the new Companies Act. While recognising its limitations, it was decided to view the ‘gain on shares’ line in IRESS as an approximation of the value realised from share-based remuneration (considering that it would at least represent the minimum value realised).
In respect of a large sample of JSE-listed companies, for the 2002–2017 period, the ‘gain on shares’ line was extracted, per executive, from IRESS. Executives for whom remuneration was denominated in a currency other than South African rand were excluded from the sample.
The types of share-based schemes per executive were also captured to provide the necessary context when interpreting the observed trends in the ‘gain on shares’ line. The sample included all companies with primary listings on the JSE (except those listed in the Financial and Basic Materials industries), provided that the company was listed for a minimum of three years. A total of 8 721 lines of information was gathered (each line relating to a specific executive for a specific year), and the number of executives per year ranged between 697 (2002) and 387 (2017).
The trend in the ‘gain on shares’ line in IRESS, as well as the percentage the ‘gain on shares’ represents of total remuneration (guaranteed package plus bonuses plus ‘gain on shares), is shown in figure 1.
Figure 1 Value realised from share-based incentives for executives of JSE-listed companies
The ‘gain on shares’ increased during the period 2002–2006, when share options were extensively employed and the JSE experienced a general increase in share prices. During the global financial crisis of 2007–2009, a severe decrease in the ‘gain on shares’ was observed. This was probably attributable to decreasing share prices on the JSE over this period (leading to fewer and smaller gains being realised). The decrease could also be attributable to the implementation of IFRS 2 (effective date 31 December 2005), whereafter it was found that many companies cancelled their existing share option schemes, and then instituted share appreciation rights and full quantum schemes. As share-based remuneration schemes usually have a lengthy vesting period, it was expected that, subsequent to the cancelling of existing share option schemes and initiating new schemes, a period would follow (the vesting period of the newly initiated schemes) during which no incentives would be exercised.
During 2010 (as economies recovered from the global financial crisis) when the newly initiated share-based remuneration schemes started to vest, a substantial increase in the ‘gain on shares’ can be observed. From 2011 onwards, a relatively stable sideways trend is seen. This is surprising, as share prices on the JSE have increased substantially since 2010, and the expectation would be to observe an increasing trend in ‘gain on shares’. However, the sideways trend might be explained by the fact that the IRESS database probably underreports the actual value realised from share-based incentives, especially after the effective date of the new Companies Act.
On comparing South Africa’s percentage of total remuneration represented by share-based remuneration to that reported in the US (81% in 2014) and Western Europe (51% in 2015), the South African percentages are much smaller. However, if the IRESS ‘gain on shares’ values between 2011 and 2017 were inflated to equal 250% of the original values, in line with the findings of Steenkamp and Wesson (2018), then the South African percentage would range between 32% (in 2010) and 47% (in 2015) – which is comparable to Western Europe.
After the effective date of the new Companies Act, it does not seem as if the value that the executives of JSE-listed companies realised from share-based remuneration was consistently and appropriately disclosed in annual reports, nor accurately captured by the IRESS financial database. After the effective date of King IV, it is important that the value realised by executives from share-based remuneration (the ‘cash settlement value’ as termed by King IV) be explicitly disclosed in annual reports. The following example illustrates the ‘cash settlement value’ disclosures required by King IV:
|Table of cash settlement values|
|Number of awards settled||Cash value of awards settled|
|Share optionsa||150 000||R1 500 000|
|Performance sharesa||200 000||R2 050 000|
|Share optionsa||75 000||R600 000|
|Performance sharesa||100 000||R1 025 000|
a Naming convention should be the same as in the Table of Unvested Awards and Remuneration Policy.
It is also advised that regulators should monitor compliance with the requirements of King IV to ensure that companies fully disclose the value realised from executive share-based remuneration. Furthermore, commercial financial databases (such as IRESS) should create data lines in respect of the King IV disclosure requirements on executive share-based remuneration and use the term ‘cash settlement value’ as the trigger when capturing the value realised upon exercise of share-based remuneration. Complete disclosure in annual reports, and accurate capturing by commercial financial databases, will allow for effective monitoring by stakeholders.
This article is based on findings from Gretha Steenkamp’s doctoral dissertation.
1 W Lazonick and M Hopkins 2016, The mismeasure of mammon: uses and abuses of executive pay data, Institute for New Economic Thinking.
2 P Kotnik, ME Sakinc and D Guduras 2018, Executive compensation in Europe: realized gains from stock-based pay, Institute for New Economic Thinking.
3 G Steenkamp, M Dippenaar, C Fourie and D Franken 2019, Share-based remuneration: per-director disclosure practices of selected listed South African companies, Journal of Economic and Financial Sciences, 12(1).
4 G Steenkamp and N Wesson 2018, Share-based incentives for South African CEOs: trends 2002−2015. South African Journal of Accounting Research, 32.
Gretha Steenkamp CA(SA), MAcc, is a Senior Lecturer at the School of Accountancy, Stellenbosch University and Nicolene Wesson CA(SA), PhD is a Professor at the Business School, Stellenbosch University.