The Steinhoff Saga Management review - University of Stellenbosch Business School

January – June 2018

Do share-based incentives allow executives to obtain undue economic gain?

share based incentives

By Ms Gretha Steenkamp and Prof Nicolene Wesson

  • Nov 2018
  • Tags Features, Leadership
19 minutes to read


Ms Gretha Steenkamp and Prof Nicolene Wesson

What share-based incentives are supposed to do
Long-term share-based incentives to executive directors have become commonplace, both abroad and in South Africa. Most stakeholders in a listed company would view these incentives as a beneficial way to align the interests of shareholders and executives. Share-based incentives can motivate executives to focus on aspects of importance to the shareholders and to the company. These incentives can also be used as a retention tool because of their long vesting periods and, in respect of equity-settled share-based incentives, can save the company a cash outflow.

Share-based incentives comprise a significant portion of executive remuneration. Critics say that these incentives could allow rent extraction – obtaining economic gain without giving any benefits in return. To enable proper governance, stakeholders (both shareholders and regulators) need to be aware of the characteristics of share-based incentives.

Although share-based incentives can be an effective way of remunerating executives, they are not without risks. Incentives might be structured incorrectly or executives might be enriching themselves without the shareholders being aware of this as share-based remuneration is difficult to understand and measure, and is often poorly disclosed. Share-based incentives could also be a motivation for executives to manipulate certain metrics to earn the remuneration associated with it.

In South Africa, with its high income inequality, more and more questions are being raised about the appropriateness of the large amounts of remuneration paid to executives of listed companies. Yet, there is no comprehensive understanding of these executive share-based incentives.

Critics say that these incentives could allow rent extraction – obtaining economic gain without giving any benefits in return.

What did this study investigate?
The aim of this study was to evaluate the trends relating to executive share-based incentives, as well as the reliability of available data sources on these incentives in South Africa.

Firstly, a trend analysis was done for companies listed on the Johannesburg Stock Exchange between 2002 and 2015. Share options were the most popular share-based incentive until 2008, but were then replaced by share appreciation rights (SARs) and later by full quantum schemes (performance and restricted shares). Compared to global evidence, SARs were popular for longer and full quantum schemes became prevalent later in South Africa. Increased use of full quantum schemes in later years signal improved alignment of executive/shareholder interest (in line with the agency theory).

Secondly, this study commented on the reliability of the IRESS financial database in recording share-based incentives, when compared to the annual financial statements (AFS) of companies. Numerous discrepancies in IRESS detracted from its usefulness as a sole data source when evaluating executive share-based incentives. Also, different disclosure practices in the AFS increased the risk that executives in South Africa could be utilising share-based incentives to extract rents from companies. Therefore, an assessment of the reliability of IRESS will help regulators to address current disclosure practices to ensure that reliable information on executive share-based incentives is available to shareholders – irrespective of the data source used.

Although share-based incentives can be an effective way of remunerating executives, they are not without risks.

More about share-based incentives to executives
A share-based incentive to an executive is defined in the International Financial Reporting Standard 2 (IFRS 2) as a payment made by a company to an executive to remunerate the executive for services rendered, where the value of the payment is based on the share price of the company. The payment can be settled in company shares or in cash.

Share-based incentives can be granted annually as a part of the executive’s package or only granted if certain performance targets are met. A vesting period follows (which usually has vesting conditions attached, e.g. the executive must stay employed or the earnings per share figure should increase by 5%) and then the incentive will vest in the name of the executive. The incentive is either immediately exercised on the vesting date or later based on the executive’s discretion.

Share-based incentives could also be a motivation for executives to manipulate certain metrics to earn the remuneration associated with it.

Classification of share-based incentives
The following types of share-based incentives were taken into account in this study:

  • Appreciation scheme – share options: Share options have been used extensively from the 1990s and provided large earnings for executives in the bull market which followed. The prominence of share options was due to companies incorrectly viewing them as ‘cheap’ or ‘free’ since they were unrecognised in the financial statements before the effective date of IFRS 2 (December 2005) and did not cause an outflow of cash. What is commonly called a ‘share option’ is actually a purchased call option for the executive of the company. Such an option conveys to the holder thereof (the executive) the right – but not the obligation – to buy shares in the company at a certain exercise price at a pre-determined date or period in the future. The executive has to stay employed in the company during the vesting period. After the vesting date, the share options may be exercised at the executive’s discretion, but options need to be exercised before the expiry date. The executives share in profits to be earned on the shares, but not in the losses.
  • Appreciation scheme – share appreciation right (SAR): A SAR is basically a cash-settled version of a share option (where the increase in share price from grant date to vesting date is paid out in cash), conditional upon the executive staying with the company. Some SARs are net-settled in shares (where the number of shares equals the value of a would-be cash payment), but the majority are cash-settled. The use of appreciation schemes (share options and SARs) is declining globally.
  • Full quantum scheme – restricted shares: Shares equal to a certain rand-value are allocated to an executive. These shares will vest in the name of the executive once an employment period has been completed. On the vesting date, the executives receive the shares at no cost.
  • Full quantum scheme – performance shares: Performance shares are similar to restricted shares, but also have performance vesting conditions attached. The shares accrue to the executive (at no cost) after a certain time period (usually three to five years) has been completed and certain performance targets have been met.
  • Full quantum scheme – phantom shares and other cash-settled plans: A phantom share entitles the owner thereof to a cash payment equal to the share price on exercise date. A share is effectively granted (similar to restricted and performance shares), but it is settled in cash to avoid dilution of the current shareholders’ interest. Other cash-settled plans may also occur where cash is paid, based on performance measures.
  • Full quantum scheme – deferred bonus: A deferred bonus scheme is where executives choose to defer a portion of their short-term cash bonus into shares of an equal value. The executive is rewarded for this deferral with the receipt of shares of an equal value at no cost, if the executive is still with the company at the vesting date.
  • Hybrid scheme – share purchase: A share purchase scheme is a type of hybrid between appreciation and full quantum. An executive purchases the shares at the ruling market price, but only has to pay the purchase price at a future date. The value that the executive receives is the appreciation in share price. However, the executive is exposed to downside risk.

Shareholders are often unaware of these rent-extraction activities.

What does the literature say about share-based incentives?
A literature review was undertaken to shed light on the theoretical perspectives underpinning executive share-based remuneration.

Most studies concur that executive share-based incentives originated as a result of agency theory. Executives are seen as agents of the principal (shareholders) and should be incentivised to act in the best interest of the shareholders. Share-based incentives were developed as a financial incentive to align the interests of the executives with those of the shareholders, as they enable exposure to similar risks (increase or decrease in the share price).

In recent years, there has been increased awareness that share options and SARs (appreciation schemes) are not ideal in aligning executive and shareholder interests, as appreciation schemes award for increases in the share price but do not expose executives to a down-side risk. As a result, full quantum schemes have been gaining ground because the risks and rewards of shareholders and executives are more appropriately aligned.

Over the years, additional theories on share-based incentives were developed. This includes institutional theory which proposes that corporate governance requirements, accounting treatment and the economic climate would influence the share-based incentives being paid to executives. Institutional theory also proposes that executive remuneration in emerging economies could be different to those in the developed world.

The managerial power or rent-extraction theory proposes that executives could use share-based incentives to extract undue remuneration from companies. Shareholders are often unaware of these rent-extraction activities.

Some view share-based incentives as a governance measure in itself – in that it aligns the financial interests of executives with those of shareholders. Most, however, believe that share-based remuneration should be governed appropriately to reduce opportunities for rent-extraction and manipulation.

Some view share-based incentives as a governance measure in itself – in that it aligns the financial interests of executives with those of shareholders.

How the research was conducted

This quantitative study used longitudinal secondary data from the IRESS financial database as well as the annual financial statements (AFS) of companies. Firstly, a trend analysis was done, which evaluated the characteristics of share-based incentives earned by the executives of 32 JSE-listed companies. To address the measurement problem relating to share-based incentives, a number of measurement bases were employed for share-based incentives. These bases included the type of schemes employed and granted, and also the realised gain on exercise of share-based incentives (instead of the grant date fair value). Secondly, the reliability of the IRESS database in respect of share-based incentives to executives was assessed by comparing IRESS data and AFS data.

The study period was from 2002 to 2015. In 2002 remuneration data first became available on IRESS (the effective date of King II). For each company, the following steps were followed per year:

  • Determine who the CEO was in that specific year
  • Extract from IRESS the data for the CEO (total remuneration as well as data regarding share-based incentives, such as type of scheme, vesting conditions and number granted)
  • Evaluate data from IRESS for possible discrepancies or incompleteness.

Both the IRESS data and AFS data were transposed and cleaned to enable analysis using various techniques and tests. Among others, the study determined the following trends:

  • There was a switch from share options to SARs in the 2000s, owing to changing accounting regulations (the expensing of share options become mandatory from December 2005 onwards). As SARs grants were replacing share options, companies were now employing two schemes (previously granted share options and the SARs).
  • In the period 2002 to 2015, share options were still the favoured share-based incentive, with more than half of the company years having a share option in use. The only other share-based incentive that was widely used was SARs.
  • From 2002 to 2004 only share options were being granted, but the number of companies granting share options decreased substantially from 2009 onwards. SARs came into use from 2006 and increased in popularity over the years 2008 to 2013, with many companies still employing them in 2015. Performance shares have been used since 2008, but only gained momentum from 2013 onwards.
  • South Africa decreased share option usage at the same time as the rest of the world (after the effective date of IFRS 2). However, SARs were more prevalent in South Africa than in the rest of the world, and for a longer period of time. The move to full quantum schemes, correspondingly, occurred only later for South Africa. Moving to full quantum schemes could be viewed as improved compliance with the agency theory, as full quantum schemes ensure improved alignment of shareholder and executive interests. Possible reasons for the prolonged use of SARs and delay in introducing full quantum schemes include the fact that South Africa was less affected by the financial recession than developed countries and that the country’s corporate governance requirements developed or were implemented at a slower pace.
  • The mean gain on share-based incentives was at a minimum of R232 258 in 2002, but rose to R1 882 471 in 2006. After 2006 the mean gain on share-based incentives decreased to a low point in 2009 (during the financial recession). After 2009 the mean gain on share-based incentives rose again to its maximum mean of R2 151 880 in 2015. It would seem that a financial recession either decreases the likelihood of executives exercising share-based incentives, or decreases the actual gain made on exercise (due to depressed share prices). Overall, the large gain made by executives on the exercise of share-based incentives could be an indication of managerial power or rent-extraction. The potential for such rent-extraction is increased due to IFRS 2 accounting for equity-settled share-based payments to employees at the grant date (rather than exercise date) fair value, and also due to divergent practises applied by companies when disclosing the gain realised on exercise − which negatively affects the data-collection process of IRESS.
  • The gain on share-based incentives was also compared to the guaranteed package of a CEO. The guaranteed package comprises salary plus other guaranteed benefits (such as pension), but excludes incentive payments (such as annual bonus and share-based incentives). Winsorised gain on share-based incentives was correlated to guaranteed package and it was found that larger companies, which are more likely to pay higher salaries, also remunerate in share-based incentives to a larger extent. From 2002 to 2015 the mean guaranteed package of a CEO increased steadily from R1 497 258 to R7 510 750. Inflation over this period was approximately 5.56% per year, which would have resulted in R1 497 258 increasing to only R2 579 776. The fact that the growth rate exceeded inflation substantially highlights the large increase in executives’ guaranteed package over the period.

… the large gain made by executives on the exercise of share-based incentives could be an indication of managerial power or rent-extraction

Taking note of the risks of share-based incentives

Share-based incentives to executives are increasingly used by listed companies in South Africa. Such incentives should align the interests of executives and shareholders and, as such, incentivise executives to increase shareholder value. However, share-based remuneration can also provide executives with an opportunity to extract rents from the company if these incentives are not properly governed and disclosed. The global debate on the justification of large amounts spent on executive share-based incentives has increased, but research has been meagre owing to the variety and complexity of such incentives as well as the poor disclosure thereof in annual financial statements.

The extent of the gain when exercising share-based incentives, combined with the fact that IRESS significantly understates the magnitude thereof, highlights the risk that executives in South Africa could be using share-based incentives to extract rents from companies.


  • The original article was published in the South African Journal of Accounting Research, 32(1), 46-70. Find the link here.
  • Prof Nicolene Wesson lectures in Management Accounting (Financial Analysis) at the University of Stellenbosch Business School. She is also the academic head of the Postgraduate Diploma in Business Management and Administration (PGD BMA). Ms Gretha Steenkamp is from the School of Accountancy at Stellenbosch University, where she lectures Financial Accounting. Ms Steenkamp is a PhD student USB.


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