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Senior staff retention in a downturn is more than just throwing money to stem the outflow of talent

16 September 2008 PricewaterhouseCoopers

In an economic downturn, staff retention issues come to the fore. Gerald Seegers, PricewaterhouseCoopers SA Director of Human Resources says that in tough conditions the war for talent heats up. “We see this especially so in the resource and engineering market, and companies are incurring significant costs in the recruitment and proactive retention of key talent.”

Seegers says that although the awarding of leveraged and performance-related share awards does not immediately address retention issues, after a period of time, when they are deeply in the money they may provide a compelling lock-in. “But because the awarding of such rights does not address the short-term retention issue it is therefore prudent to address retention matters pro-actively and before they come matters of dire urgency.”

Seegers says the payment of regular unconditional cash amounts during tougher times can carry the significant risk of being transformed into permanent expectations of a base pay. “This can be a very costly annuity liability for the company, especially if the plan has been broadly applied. After say three years, many of the participants will probably still represent key talent that will require retention. These participants have become accustomed to an elevated level of guaranteed income, and sudden termination of these payments will be problematic. And such cash-based plans can lead to a significant risk of a large proportion of key talent leaving after three years, as all participants will come to the end of the plan simultaneously.”

Seegers says that with these types of cash awards, there is also no alignment of shareholder and management objectives, as the retention payments are guaranteed and are totally unrelated to company performance and share price.

“The tax inefficiency of these up-front cash plans (participants receive an after-tax payment but are required to refund the full pre-tax amount should they have breached the terms of the plan, could lead to suspicion and cynicism from participants. In our experience, loyalty and high levels of retention are enjoyed by companies that offer more than merely monetary compulsion to stay. They retain their key staff through exceptional levels of leadership, business and personal growth, travel and training opportunities, and general excitement regarding the future of the company. In this regard it is extremely important that mentoring, succession and career planning are a key focus of any retention plan.”

Seegers says that a mix of restricted stock and share appreciation rights would be ideal to encourage retention. “But participant lists should be very selective and include only those key individuals with significant value to the company, whose departure would really be harmful.”

One possibility is to consider exceptional awards of “Restricted Stock Units” to qualifying individuals on an annual basis, over and above the normal reward package. “The awards should be made annually after appraisal of the market for talent in each year, and the performance and potential of the individual at that time.”

Seegers explains that Restricted Stock Units are cash-settled units with a value linked to that of the underlying share. “They usually do not qualify for dividends, although one can capitalise the dividends into the unit’s value to reflect the total shareholder return of the underlying share. Restricted Stock Units have no other company performance conditions, but vest after three years, provided the holder is in the employ of the company and is in good standing.

And since the units are related to the share price and are cash-settled, they will require recognition under IFRS 2 as a cash-settled share-based payment, amortised over the three-year vesting period, and marked-to-market in line with share price movements. The settlement of these awards at vesting date is likely to be tax deductible in the hands of the employer company and taxable as income on vesting in the hands of the participant.

“The grant value of these awards could be linked to the benchmark values, but they would be considered on an annual basis, rather than guaranteeing a three year payment. Three years of annual Restricted Stock awards would also buy the company six years of service, rather than just three, and the awards can be continued or discontinued on a rolling basis on the basis of the business context at the time.”

Seegers emphases that mentoring, succession and career planning and all other non-financial aspects of retention programmes should be pursued vigorously, in conjunction with the financial incentives to stay. “Careful thought should be given to posts that have valuable incumbents, but require BEE transformation. Relatively higher levels of Restricted Stock awards could be made to these incumbents, with vesting conditions based on identification, mentoring, and successful hand-over to an effective empowered BEE successor.”

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