The David Leckie share sell-off is a neat example of why equity incentive plans can fail to align with shareholder and executive interests, writes Adam Schwab.
Seven Network executives, David Leckie
and Bruce McWilliam
disclosed on Monday to the ASX that they had sold a large number of shares in their employer pursuant to a "cost collar financing arrangement". Leckie later told the Financial Review
that "in these times, when it is impossible to roll over cost collars, it’s necessary and prudent to sell the shares." Leckie also claimed that the share sale did not affect his "view of Seven Network going forward [with] the company well placed with a strong balance sheet."
It is understood that the shares sold by Leckie were accumulated following the exercise of performance options (Leckie was issued with 3 million options upon his appointment in 2003 and a further 3 million in June 2005 when he renewed his employment contract). As a result of the 'collar and cap' arrangement, Leckie was able to receive an average selling price of $8.97 for the 2.99 million shares disposed. Courtesy of hedging his exposure to Seven, Leckie was able to reap proceeds of $26.8 million. Had Leckie's exposure not been hedged, his proceeds would have been only $18.05 million
Similarly, former media lawyer and News Corp executive, Bruce McWilliam was able to sell 500,000 Seven shares at a price of $8.29 (collecting $4.45 million). Without those hedging arrangements in place, McWilliam's proceeds would have been $3.02 million.
It is important to note that Leckie and McWilliam did absolutely nothing wrong in protecting their equity position in Seven. Many executives will sell their share-holding upon the exercise of options (in some cases, the sale is necessary at least in part to fund the exercise price). In continuing to hold Seven shares (albeit with downside protection), Leckie and McWilliam were at least in-part aligning their interests with the interests of Seven Network shareholders. Further, given executives are often solely reliant on the performance of their employer for their income, in the interests of risk mitigation, they would be advised to diversify their wealth away from their lone income source.
However, the Leckie/McWilliam situation a neat example of why equity incentive plans which require only relatively short vesting periods will completely fail to align shareholder and executive interests.
When Leckie departed Nine for Seven in 2003, Seven's share price was around $5.00. At that time, Leckie was handed three million options
with exercise prices ranging from $5.00 to $7.00. 1.5 million of those options were exercisable within one year (and could be re-tested until 2008) and would vest if Seven's total shareholder return exceeded the S&P Accumulation Index. Another one million options were able to vest the following year. As Seven's share price improved (partially due to Leckie’s management abilities, but also due to strong global economic conditions) the options became increasingly valuable.
At their nadir in 2007, the "in the money" value of Leckie's options was more than $20 million. After peaking in late 2007, Seven shares fell dramatically, (in line with most media companies), as advertising revenue slumped contracted. Seven shares are now around $6.15, around 25% higher than when Leckie and McWilliam arrived (and reducing the value of the options to around $500,000).
In this regard, it is noted that Seven's 2008 Annual Report claimed, "the performance linked component is derived only in circumstances where the individual has met challenging personal objectives and corporate performance hurdles, (in respect to options), which contribute to the Seven Group’s overall profitability and performance."
However, while Seven may have set semi-challenging performance hurdles, its equity plan highlights the inherent problems in allowing equity instruments to vest in less than five years. Because Leckie’s options were able to vest as soon as one year after their grant, he was able to benefit from what was a relatively a short-term spike in Seven’s share price (and subsequently, lock in almost $10 million of those gains through a shrewd hedging policy).
If Seven has required executives to hold shares (or other equity instruments) for a period of five or ten years (as suggested by corporate governance firm, Regnan) executives would be facing a dramatic reduction in wealth, in a similar manner to shareholders. Instead, Leckie has been able to collect a ten million equity windfall as shareholders have witnessed the value of their holding fall by approximately 55% in the past 18 months.