Beyond The Paycheque: A Practical Guide To Executive Compensation In Sa

Navigating the Maze of Executive Compensation:

A Practical Guide to Unlocking True Economic Value – Insights by Dr Chris Blair

As a South African executive, you've likely scrutinised your compensation package and pondered: does this truly reflect the value I bring to the table? Total earnings – encompassing fixed pay, short-term incentives (STI), and long-term incentives (LTI) – can resemble a complex JSE puzzle. Fixed pay is your dependable base salary and benefits, covering everyday essentials. STI provides a performance-driven bonus, often linked to yearly goals like revenue targets or EBITDA margins. Then comes LTI, typically in appreciation or full shares, aimed at syncing your goals with shareholders over multiple years. But the real question is: how do you gauge its genuine economic benefit? Companies structure pay this way to encourage sustainable growth, not fleeting gains – think of it as rewarding a Springbok captain not just for one match, but for winning the World Cup series. For the average South African, this explains why executives receive intricate packages: it's to ensure leaders deliver lasting value for investors, justifying those high figures in the headlines.

In this article, we will explore how you can assess the economic worth of your total package from an executive's perspective. We will emphasise LTI's nuances: contrasting the 'face value' (the advertised sum) with actual payouts post-performance hurdles, expanding to common types used in JSE-listed firms, and the risks of total shareholder return (TSR) without dissecting the peer group. We'll keep it accessible – no advanced finance required – while demystifying why these mechanisms exist, making it clear to anyone why exec pay is not simply a fat cheque.

Why Total Earnings Are Structured This Way

Picture steering a ship through the stormy Cape waters: fixed pay keeps you afloat daily, STI rewards navigating key waves, and LTI pays if you reach port prosperously. This isn't random; it is to deter short-sighted moves, like slashing R&D for quick profits, which could sink the firm long-term. Research highlights that such structures align executives with shareholders, boosting firm performance (Edmans, Gabaix and Jenter, 2017). For the man on the street, it's akin to a miner's wage: base for the shift, bonus for output, and shares for the mine's enduring success. In South Africa, with its unique challenges like load-shedding and inequality, this ensures leaders focus on resilient growth.

Yet, valuation is tricky. A R10 million LTI face value might seem equivalent across offers, but economic reality – factoring vesting odds and dividends – differs. Studies show pay often underdelivers on promised value due to overlooked risks (Frydman and Jenter, 2010). As an exec, ask: what's my likely take-home, and how does it stack up?

Debating LTI - Face Value Versus Real Economic Outcome

First, let's debate comparing LTI face value to its economic payout, accounting for performance hurdles. Face value is the grant-date amount, reported for transparency under King IV guidelines. But it's like valuing a Johannesburg property by list price alone – ignore the fine print, and you're in for surprises.

Common hurdles in South African LTIs include:

• Earnings Per Share (EPS) growth: Tracks profit per share. Popular in firms like banks, it vests if targets (e.g., 8% yearly) are met. Vesting averages around 60%, per global surveys adapted to JSE contexts (Edmans, Gosling and Jenter, 2023).
• Return on Equity (ROE): Gauges profit from equity. Suited to banks like fnancial firms, rewarding efficient capital use.
• Total Shareholder Return (TSR): Benchmarks share growth plus dividends against peers. Vesting hovers at 55-60%, but market volatility sways it (Buck et al., 2003).
• Strategic metrics: Such as B-BBEE scores or sustainability goals, rising in SA to address social imperatives (Haque and Ntim, 2020).
• Time-based vesting: Vest after tenure, e.g., three years. High vesting (near 100%), but seldom standalone as they lack performance drive.

To illustrate, consider two JSE scenarios. Suppose Company A offers a R10 million LTI face value, fully TSR-linked, sans dividends. Company B offers the same, split 50/50 EPS and time-vesting, with dividends. With a 3% yield over four years, Company B’s could be 12% more valuable at grant (Oehmichen, Wolff and Zschoche, 2021). Factoring vesting (55% for TSR, 60% for EPS), Company B’s exec might realise 50% more – R6.6 million vs R4.4 million (derived from SA studies like Gyapong, Khaghaany and Ahmed, 2020). Why? TSR rides market waves, while EPS rewards controllable factors, and dividends add like compound interest.

From your executive lens, this underscores pay inefficiencies. Packages appear competitive but falter on hurdles or dividends (Bezuidenhout, 2016). Advice: Demand 'realisable pay' projections from remuneration committees, showing scenarios based on past data. Compare like budgeting a family holiday: headline cost vs actual expenses. For the public, this complexity ties rewards to real achievements, curbing unjustified windfalls.

“Advocates for face value stress its simplicity for oversight. Yet, it breeds disparities. If vesting averages 50% in SA SOEs, you're underpaid relative to promises (Ngwenya and Khumalo, 2012). Economic focus promotes equity, aiding talent retention amid SA's brain drain.

The TSR Dilemma - Evaluating Outcomes Without Peer Group Scrutiny

Next, assessing LTI when TSR lacks peer deep-dive. Relative TSR ranks your firm's return against comparators, vesting above median. It seems fair – outperform to earn – but mismatched peers turn it into a lottery, not merit.

Key issue: Peers may have divergent risks (beta volatility). High-beta firms surge in upturns but plummet in downturns, distorting ranks (Edmans and Gabaix, 2016). If your steady Consumer Staples firms compete with volatile miners, vesting feels random, prompting risky bets or exits (Deysel and Kruger, 2015).

Example: Firm A (TSR 11%, beta 1.2) vs Firm B (TSR 9%, beta 0.9). Raw TSR favours Firm A, but risk-adjusted (TSR minus risk-free rate over beta) highlights Firm B’s stability (Bellocq and Vaquier, 2021). Sans this, low-risk execs feel shortchanged.

TSR persists for its clarity and shareholder alignment. To the layperson, it means execs prosper only if investors do. But in diverse JSE sectors, peers seldom align perfectly, heightening bias.

As an exec, probe: Who are peers? Match our risk? Seek risk-adjusted TSR via tools like Sharpe ratio – simple calcs level play (Jachi, 2021). If mismatched, push for hybrids like absolute TSR.

Empowering Your Evaluation

Assessing total earnings means piercing the veil. For LTI, weigh face value against hurdles' outcomes via vesting and dividends; for TSR, demand peer analysis to dodge pitfalls. These intricacies ensure execs earn through value creation, clarifying big pay to South Africans.

Empower yourself: Compare scenarios, challenge designs, consult independently. Your package then fuels true success.

This article is based on research conducted by Dr Chris Blair of 21st Century, one of the largest remuneration and HR consultancies in Africa. Please contact us at [email protected] for any further information.

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