How can non-state-owned listed companies make better use of equity incentive plans as a means of encouragement? Yang Liang, Board Secretary, Livzon Pharmaceutical Group Inc, shares his experience on the planning and implementation in this area.
Currently, listed companies in the Mainland generally implement employee incentives in two ways – equity incentives and employee stock ownership plans. Equity incentives refer to long-term incentives for directors, senior managers and other employees of listed companies based on the company’s stocks. The main methods for offering equity incentives include restricted stocks and stock options (see Glossary for an explanation of the terms used in this article).
An employee stock ownership plan refers to a system arrangement whereby a listed company legally allows employees to obtain the company’s stock and hold it for a long period of time according to the wishes of the employees. The rights and interests of the stock are allocated to employees in accordance with the plan design. Currently, the stock ownership plans available in the market mainly include private placements, financing, award fund, repurchase and stockholder grants.
Different incentive methods have their own advantages and disadvantages. For listed companies, different incentive plans need to be adopted based on actual conditions. Generally speaking, equity incentive plans balance incentives and constraints well, while employee stock ownership plans focus on benefit-sharing. In the design of incentive schemes, the key elements can generally be summarised as relating to ‘four areas’ (person, quantity, price and timing) and ‘two sources’ (stock source and capital source).
Creating a multilevel equity incentive system
Following its goal to become a leader in the pharmaceutical industry, Livzon Pharmaceutical Group Inc (Livzon) has been actively implementing a variety of equity incentive measures since 2014. Depending on the incentive purpose and scope level, it has adopted various forms of equity incentives including employee stock ownership plans, restricted stocks, stock options and subsidiary-level incentives, which provide strong support for the sustainable growth of the company’s business.
At the base of the pyramid, Livzon has formulated standardised equity incentives, such as stock options and restricted stocks, for executive-level employees and above and core personnel within the group. Middle-level management and above, together with core personnel of Livzon’s business units or subsidiaries, participate in the investment or transfer of equity of these business units or subsidiaries. At the top of the pyramid, Livzon adopted a ‘business partner share ownership scheme’ to cover a small number of core personnel who play a key role in the future strategy and business of the company.
In 2014, against the background of management changes at Livzon and the successful conversion of B shares into H shares after listing on the main board of the Stock Exchange of Hong Kong, Livzon initiated planning and then implemented its first equity incentive plan. This is to enhance the morale and governance standards of the team. Some 10 million shares were issued to 483 middle and senior management, and core technical personnel. In 2018, Livzon officially launched a stock option plan with a total of 1,045 participants and a total of 15 million shares, accounting for 2.71% of the company’s total shares.
In 2020, on the basis of the existing wide coverage of the equity incentives, Livzon launched a medium to long-term business partner share ownership scheme for its core management, which is based on the modal of excess profit assessment and reward fund. From 2020 to 2029, Livzon will implement multiple, independent phases of its share ownership schemes.
Incentive mechanisms are crucial to the company’s long-term development. For the company, on the one hand, the distribution of performance stocks can reduce the cost of cash expenditures, which is conducive to stabilising the stock price. On the other hand, the partner incentive mechanism can attract more domestic and foreign talent to join the company.
Equity incentives create value for enterprises
According to Livzon’s experience in implementing multilevel equity incentives, from planning and approval to market value management, listed companies need to ensure smooth communication with key decision-makers, such as managers and major shareholders, and with internal supporting departments and external service organisations.
Equity ownership incentives should essentially serve corporate strategy and business development. The choice of incentive methods should be based on the company’s performance, and should be able to bring stability and attract talent. A stock incentive plan can be designed to be effective, exercisable and sustainable from the perspective of time, price, quantity, people and funding sources.
- In terms of effectiveness, the incentive plan must cater to the interests of shareholders and guide managers to bear shareholders’ concerns and interests in mind when taking decisions. The plan should enable managers to generate proper expectations and achieve the desired goals.
- In terms of operability, consider whether the plan is feasible – in particular whether participants can reasonably take on the risks involved, whether the incentive cost is reasonable, whether the funds can be properly sourced and whether the equity pricing method is reasonable and clear enough.
- In terms of sustainability, it is important to avoid equity immobilisation. When a listed company launches an equity incentive plan, it can set up reserved equity and the reserved proportion usually does not exceed 20% of the amount of equity to be granted under the equity incentive plan.
In determining individual performance indicators, performance evaluation tools such as key performance indicators or the balanced scorecard tool, can be introduced. Listed companies might wish to be bold in setting performance indicators and long-term goals – after all, equity incentives have a future orientation.
Today, equity incentives have become one of the effective means of market value management for listed companies. Based on Wind data, China International Capital Corporation established an index with the sample base of companies that were implementing or had implemented equity incentives from 2010 to 2020. The data showed that the A share companies implementing equity incentives significantly outperformed the main indexes. In fact, aligning the interests of managers and listed companies can increase investor confidence. More and more listed companies attach importance to the establishment of long-term incentive mechanisms and the use of other market value management tools. They can increase their rate of return on equity incentives.
Since its listing, Livzon has attached great importance to corporate social responsibility and continues to improve its ability to give a return to investors. It has experienced a sharp increase in its market value from 2011 to 2020. However, we must also be clearly aware that the existing equity incentive mechanisms still have their own limitations, and the improvement of corporate governance is a long-term task. In the future, Livzon hopes to work with more listed companies to explore the optimal incentive mechanisms and possibilities for improving corporate governance.
Yang Liang, Board Secretary
Livzon Pharmaceutical Group Inc
Restricted stocks. Restricted stocks refers to company shares acquired in accordance with the conditions specified in an equity incentive plan, whose transfer and some other rights are restricted.
Stock options. Stock options refers to rights granted by a listed company to participants to purchase a certain number of company shares under predetermined conditions within a certain period of time.
Key performance indicators (KPIs). KPIs are target-oriented quantitative management indicators that measure process performance by setting, sampling, calculating, assessing and analysing the key parameters of inputs and outputs in internal processes. They are also a tool used to divide strategic business goals into exercisable work targets, constituting the basis of business performance management.
Balanced scorecard (BSC). As one of the common performance evaluation methods, BSC is a new performance management system that evaluates the implementation of business strategies by exercisable indicators and targets from four different perspectives: finance, customers, internal operation, and learning and growth.