Equity-based income: A formula that drives …...Equity-based income: A formula that drives business...

Equity-based income: A formula that drives business performanceLIVE WebcastTuesday 7 July 2020 | 10:00 a.m. – 11:00 a.m.

Equity-based income: A formula that drives business performanceLIVE Webcast

Tuesday 7 July 2020 | 10:00 a.m. – 11:00 a.m.

Ang Weina (Moderator)National Global Employer Services LeaderDeloitte

Chee Ying ChengTax Executive Director – Global Employer ServicesDeloitte

Mark Nicholas TeohExecutive Director – ConsultingDeloitte

Datuk Jory LeongJoint Managing PartnerIza Ng Yeoh & Kit

Leonard WooExecutive Director – Financial Advisory (Valuationand Modeling)Deloitte

Izzad ShamsudinPartner – Audit & Assurance (Advisory Services)Deloitte

Equity-based income: A formula that drives business performance | LIVE WebcastDeloitte Tax Services Sdn Bhd | 2020 3

In this webinar, we will discuss:

• Why is equity plan an option to consider?

• How can an equity reward plan drive performance?

• Should it be limited to executive level or can it be a broadbased rewards?

Agenda


Incentivising Employees in the time of COVID-19As the world responds to COVID-19, organisations may face challenges in how they compensate andincentivise their employees

RESPONDManage continuity

THRIVEPrepare for the next normal

RECOVERLearn and adjust

To address these challenges, organisational leaders must plan for three key periods in the crisis…

…because “the greatest danger in times of turbulence is not the turbulenceitself, but to act with yesterday’s logic”1

1 Managing in Turbulent Times by Peter F. Drucker (1980)


Employee Share Schemes Then and NowBefore COVID-19, Employee Share Schemes were leveraged as part of a broader rewards portfolio toincentivise top talent

Now, financial priorities shift and many uncertainties remain, organisations may need to shift their view on howthey identify, evaluate, and reward the right talent

Talent Identification

High performers, exceeding their KPIsThen

No

w

Talent critical to business continuity& new business strategies

Then

No

w

Measurement Criteria

Business-as-usual key performance indicators New key performance indicator thatsupport the needs of the business now

Reward Type

Mix of short- and mid-term cash views (e.g.,one-time bonus and retention bonuses)

Then

No

w

Mix of mid- to long-term cash views (e.g.,ESOS, RSU, ESPS)


Challenges for Human Capital LeadersHR and business leaders will need to consider five key aspects of developing and executing newincentives plans guided by COVID-era context

Rapidly shifting talent needsmeans incentives may no longerbe limited to high potentials andexecutives. Key positions acrossthe organisation may need to beconsidered for incentive programsto retain business-critical talent

New WorkforceRequirements

The criteria for determining theright level of incentive may needto include additional dimensionsnot previously measured to drivenew needed behaviors

New MeasurementCriteria

Organisational leaders must findthe right mix of short-, mid-, andlong-term incentives that meetsthe needs and desires ofemployees while remaining cost-efficient during this period.

The Right Incentives

Both existing and potential talentwill be sensitive to any changes intheir cash flow, and it is critical tocarefully develop the rightmessages and deliver them at theright time to manage employeeexpectations

Managing the Changes

There will be a time to reconsiderthe incentive strategy as we moveinto the next normal. Establishingthis expectation from thebeginning is critical to asuccessful long-term strategy

The Right Exit Strategy

FIVE KEY ASPECTS

THE COVID CONTEXT

What principles serve as the foundation for your compensation philosophy, program, and policies?

Position Value• Job evaluation (internal)

• Market pricing (external)

Human Value• Purpose

• Fairness

• Transparency

• Growth

• Collaboration


Make a PlanWhile responding to immediate talent and cash-flow needs is important, the medium- and long-termplan must be considered from the beginning

RESPOND

Manage continuity

THRIVE

Prepare for the next normal

RECOVER

Learn and adjust

New WorkforceRequirements

New MeasurementCriteria

The Right Incentives Managing the Changes The Right Exit Strategy

Identify new talent groups toincentivise based on business

strategy

Understand currentplans

Determine newmeasurement

criteria

Identify the right incentivesfor both the organisation and

employees

Implementchanges Evaluate benefits

(financial & talent-related

Continually monitoreffectiveness

Manage theconversation with

employees

Make changes to plans asnecessary Develop flexible

remunerationapproaches

Start

End

Make adjustmentsto move into the

next normal

Ongoing activities throughout the Recovery Period


Types of Employees Share Scheme

Employee Share Option Scheme(ESOS)Employees are given the right to buy anumber of shares at a price fixed atgrant for a defined number of years intothe future

Employee Share Purchase Plan (ESPP)This is similar to ESOS but the method ofpurchase is usually through salarydeduction

Restricted Share AwardsEmployees are granted actual shares forfree or less than their market value, oncecertain restrictions are met (i.e.performance target, number of years withthe company etc.)

Stock Appreciation Rights (SAR)Employees are given the right to receivecash award equal to the appreciation invalue of a certain number of shares at aspecific time


The actual cost of share-based payment awardsWhy share-based payment awards need to be valued?

No cash outlay ≠ Zero cost(Equity-settled share-based

payment)

The real cost of running the businessshould be estimated

Estimate liability and payoff(Cash-settled share-based payment)

Company is required to remeasurethe fair value of a cash-settled awardat each reporting period date and on

settlement. Cash-settled award ispresented as a liability until the

award is settled

IFRS compliance

Cost of share-based payment mustbe estimated to comply with IFRS 2to reflect the effects in its profit or

loss and financial position


Types of share-based payment awardsCommon instruments used in the market

Equity Share Options(“ESO”)

Share Appreciation Rights(“SAR”)

Employee Share Purchase Plan(“ESPP”)

Non-vested Shares /Restricted Shares

“ESO gives employees the right but not theobligation to purchase equity shares at a

predetermined price for a specified period.”

Characteristics

• The strike price can be equal to (at themoney, greater than (out of the money),or less than (in the money) the marketprice of the underlying share at the dateof granting of the ESO

Pros

• An instrument to drive performance foremployees with line of sights

Cons

• Employees need to incur cash upfront toexercise the options

• Uncertain to the employees as therewards could be zero if the market pricedoes not increase above the strike price

“ESO gives employees the right but not theobligation to purchase equity shares at a

predetermined price for a specified period.”

Characteristics

• The strike price can be equal to (at themoney, greater than (out of the money),or less than (in the money) the marketprice of the underlying share at the dateof granting of the ESO

Pros

• An instrument to drive performance foremployees with line of sights

Cons

• Employees need to incur cash upfront toexercise the options

• Uncertain to the employees as therewards could be zero if the market pricedoes not increase above the strike price

“Awards entitling employees to receive cashor equivalent to any excess of the market

value over a stated price.”

Characteristics

• Allows an employee to share in theappreciation of the employer's stockwithout having to make any cash outlay

Pros

• Usually no dilution to existingshareholders other than a cash outlay tothe employees

Cons

• Requires cash outlay by the employer

• Cash-settled SARs are accounted for asliability awards (FV of compensationexpense is re-measured at each reportingperiod until award settles).

“Awards entitling employees to receive cashor equivalent to any excess of the market

value over a stated price.”

Characteristics

• Allows an employee to share in theappreciation of the employer's stockwithout having to make any cash outlay

Pros

• Usually no dilution to existingshareholders other than a cash outlay tothe employees

Cons

• Requires cash outlay by the employer

• Cash-settled SARs are accounted for asliability awards (FV of compensationexpense is re-measured at each reportingperiod until award settles).

“A plan that allows employees to purchasestock at a discount price from market price.”

Characteristics

• The discounted purchase price built intoESPPs can result in the employeesrealizing a profit (upon exercise and sale)even if the current share price is lowerthan the share price at the grant date

Pros

• Employees will always be rewardedregardless of the market price

• Less dilution

Cons

• Employees need to incur cash upfront topay for the shares (although maybe ondiscounted price)

• Small number of shares will be issued andemployees will have limited upside if themarket price increases

“A plan that allows employees to purchasestock at a discount price from market price.”

Characteristics

• The discounted purchase price built intoESPPs can result in the employeesrealizing a profit (upon exercise and sale)even if the current share price is lowerthan the share price at the grant date

Pros

• Employees will always be rewardedregardless of the market price

• Less dilution

Cons

• Employees need to incur cash upfront topay for the shares (although maybe ondiscounted price)


“Shares that not yet issued because theagreed-upon consideration has not been

met.”

Characteristics

• The restriction on sale of non-vestedshares is due to the forfeitability of theshares if specified events occur or do notoccur

• Usually not entitled to receive dividends

Pros

• Less dilution

• Upon vesting employees will get a rewardregardless of the market price

Cons


“Shares that not yet issued because theagreed-upon consideration has not been

met.”

Characteristics

• The restriction on sale of non-vestedshares is due to the forfeitability of theshares if specified events occur or do notoccur

• Usually not entitled to receive dividends

Pros

• Less dilution

• Upon vesting employees will get a rewardregardless of the market price

Cons



Common valuation approachesHow can we value these share-based payment awards?

Valuation

approachesTypical instruments Description Pros & Cons

Black-Scholes-Mertonmodel

• Employee SharePurchase Plan

• Equity Share Options(European style)

A model that uses a differential equation to solve foroptions prices with current stock prices, strike price,expected interest rates, expected volatility, time toexpiration and expected dividend.

• Simplest but less flexible

• Closed-form model – Cater for limited scenario because itassumes that stock returns are normally distributed and thatvolatility, dividends, and risk-free rate inputs are constant

Lattice model• Equity Share Options

(American style)

An iterative approach that assumes that there aretwo or more possible movements in stock prices andpayoffs of option under these scenarios are presentvalued.

• Requires robust modeling but allows to value more complexawards

• Open-form model – Allows to vary key assumptions such asvolatility of the underlying shares, the interest rate, and thedividend yield as changes in these factors are expected to occurover the contractual term of the option

Monte Carlo simulationmodel

• Employee SharePurchase Plan andEquity Share Optionswith complexfeatures

A simulation of the possible future stock prices tofind the discounted expected payoffs.

• Allow for much of the same assumption-input variability aslattice-based models but within the context of path-dependentoptions where the outcomes consider the path of the previousoutcomes and not just the current conditions

• Provide better modeling flexibility compared to lattice modelsbut difficulty to apply this method to pricing American options.


Key variables used to derive the value of share-based payment awardsSelected valuation technique needs to incorporate at least the following six characteristics of theaward

Key variables DescriptionDirectional change of

inputImpact on fair value

Expected termExpected term is the period that it is expected to be outstanding, that is, the

period from the grant date to the date of expected exercise or settlement.

Expected volatility of the

underlying asset

Expected volatility is an indication that the share price fluctuation from the

mean of the share price. A fluctuation in share price would, therefore, increase

the likelihood that a holder of an option can benefit from the fluctuation.

Exercise/strike price

Exercise price is the amount of cash an employee must pay to exercise the

award. The exercise price is most commonly on the performance objectives set

by the employer.

Current market price of

the underlying

The current market price for an award granted by a public company is usually

the quoted closing price of the company's common stock on the date of grant.

Expected dividend yield

of the underlying

The expected dividends or dividend rate that will be paid out on the underlying

shares during the expected term of the option. Option holders are not entitled

to receive those dividends before exercising their options.

Risk-free interest rate

The risk-free rate is a theoretical interest rate at which an investment earns

riskless return. Options are valued with a risk-neutral assumption under which

all assets may be assumed to have expected returns equal to the risk-free rate.


Other practical issuesWhat to consider before issuing share-based payment awards?

1

2

3

4

5

Inputs can be difficult to estimate. The choice of the peer company or appropriate source of data is subjective and morechallenging to determine.

May require an overall valuation of the business enterprise to value share-based payment awards for non-public entity.

A share-based payment award with complex conditions cannot be valued without complex modeling.

Determine the appropriate expected term based on reliable data.

There are various factors to consider in estimating forfeitures.


At a glance

MFRS 2: Share-based payment accounting considerations

There are different types oftransactions under share-basedpayment transactions, theseinclude:• Equity-settled – The entity

receives goods or services

either as consideration for its

own equity instruments

(including shares or share

options), or has no obligation

to settle the transaction with

the supplier.

• Cash-settled – The entity

acquires goods or services by

incurring liability to settle the

transaction in cash (or other

assets) for amounts that are

based on the price of equity

instruments.

Key terms under MFRS 2• Vesting condition – can be

either a service condition (e.g.

Requirement to complete a

specified period of service) or a

performance condition (e.g.

Specified target has to be met in

addition to completion of

service condition).

• Non-vesting condition – Any

conditions without service

condition.

How are share-basedpayments accounted for?

• Share-based paymentstransactions are recognisedas assets or expenses in thefinancial statement.


Examples of share-based payment transactions: Equity-settled


Share options withnon-market service

condition

Shares with non-market performance

condition

Share options withmarket performance

conditionAn entity grants 100 share

options to each of its 500

employees as

compensation for services

to be rendered by the

employees during the

following three years of

employment.

Each grant is conditional

upon the employee

remaining in employment

for the full three years.

An entity grants 50 shares

to each of the members of

its executive board,

provided that the member

remains in the entity’s

employment for the next

five years and the volume

of sales reported over the

five year period increases

by 40%.

An entity grants 1,000

share options to a senior

executive, conditional upon

the executive remaining

employed until the end of

two years.

In terms of the agreement

between the entity and the

executive, the share

options cannot be

exercised unless the share

price has increased by 25%

by the middle of the

second year.

Shares to purchasegoods from supplier

conditionAn entity in the

manufacturing business

purchases 1,000 units of

raw material from a

supplier.

In terms of its agreement,

the entity settles the

transaction by issuing 2,000

of its shares to the supplier

as consideration for the

raw materials acquired.


Examples of share-based payment transactions: Cash-settled


An entity purchases stock (inventory) from a

supplier. The terms and conditions of the

agreement provide that the consideration is a

cash payment due six months after the stock is

delivered.

The amount of the cash payment is based on the

closing share price at that delivery date.

Purchase of stock

As part of its remuneration package, an entity

grants 250 share appreciation rights (SARs) to

each of its 600 employees, provided that the

employees remain in the entity’s employment

for the next four years.

This means that the employees will become

entitled to a future cash payment based on the

increase (appreciation) in the entity’s share price

from a specified level over a specified period of

time.

Employee share appreciationrights


Recognition and measurement principles


Basic recognition principles Basic measurement principles

Past services - If the shares vest immediately, theservices rendered have been received (i.e., pastservices). Consequently, the related expense isrecognised in full for services rendered on grant date.

Future services - If the shares do not vest immediately,

the services to be rendered as consideration for those

shares will be received in the future (i.e. during the

vesting period). The related expenses is recognised as

the services are rendered during the vesting period.

Equity-settled – At the fair value of the goods orservices received. If the fair value cannot be estimatedreliably. the entity shall measure the fair value,indirectly, by reference to the fair value of the equityinstruments granted. That fair value must notsubsequently be revised.

Cash-settled – At the fair value of the liability. Until the

liability is settled, the entity shall re-measure the fair

value of the liability at the end of each reporting

period and at the date of settlement, with any

changes in fair value recognised in profit or loss for

the period.


Recognition and measurement principles (continued)


Equity-settled transaction

Acquisition of goods Rendering of services

Dr/(Cr)Increase/

(Decrease)Dr/(Cr)

Increase/(Decrease)

Assets X Increase

Equity (X) Increase (X) Increase

Expenses X Increase

Acquisition of goods Rendering of services

Dr/(Cr)Increase/

(Decrease)Dr/(Cr)

Increase/(Decrease)

Assets X Increase

Liabilities (X) Increase (X) Increase

Expenses X Increase

Cash-settled transaction


Employees Share SchemeKey tax highlights

Corporate Tax

• New shares vs Treasury shareso New shares – newly issued shareso Treasury shares – shares that were previously issued

but was repurchased, redeemed or acquired by thecompany and not cancelled.

• Timing of deduction of expenditure on treasury sharesacquired by the company:-

o The company transferred the treasury shares to theemployee; and

o The employee acquired the legal and beneficialinterest in the treasury shares.

• Timing of deduction of expenditure on treasury sharesrecharged from holding company:-

o Date the shares are transferred; oro Date the payment is made to the holding company;o Whichever is later.

Employment Tax

• Taxing point of share benefit – Section 25(1A) of ITAThe gross income from an employment in respect ofany right to acquire shares in a company of the kindto which paragraph 13(1)(a) applies, shall where theright is exercised, assigned, released or acquiredin the relevant period be treated as gross income of therelevant person for that relevant period.

• Employer obligation:o Share plan notification – Notify the MIRB within 30 days

after the expiry of the period of acceptance of the sharebeing offered

o Payroll withholding

o Social security (i.e. EPF, SOCSO)

o Annual tax reporting – Report the share benefit in theemployee’s Statement of Remuneration (Form EA) andEmployer’s Return (Form E)

LEGAL PERSPECTIVEOF EMPLOYEE SHARE

SCHEMES

IZA NG YEOH & KIT

Eligibility

•Employees - full-time, part-time, contractual.•Directors - executive and non-executive.•Company can specify criteria such as full-time

employees only, not probationary, minimumseniority, minimum years of service etc.

IZA NG YEOH & KIT

Eligibility

Exercise Price

• No restriction.

Private Company

• If the scheme is part of an IPO, the exercise pricecannot be less than the IPO offer price.

• If the scheme is implemented any other time, theexercise price cannot be less than 90% of the 5-day weighted average market price.

Public Listed Company

IZA NG YEOH & KIT

Maximum Allocation

• No restriction.

Private Company

• Main Market: <= 15%• Ace Market: <= 30%• If director or employee holds >= 20% of issued

shares, he/she cannot be allocated more than 10%of the ESS issuance.

Public Listed Company

IZA NG YEOH & KIT

IZA NG YEOH & KIT

Timeline

GrantDate

Exercisable Date/Vesting Date

ExerciseDate

Vesting Period Exercisable Period Moratorium Period

• Is the ESS a term of employment?

IZA NG YEOH & KIT

FAQ

•How long shall the ESS last?

IZA NG YEOH & KIT

FAQ

•What if there is M&A activity within the group?

IZA NG YEOH & KIT

FAQ

•What if a company has an existing ESS prior to IPO?

IZA NG YEOH & KIT

FAQ

•For private companies, how to regulate relationshipwith employees who become minority shareholders?

IZA NG YEOH & KIT

FAQ

Equity-based income: A formula that drives business performanceLIVE Webcast

Tuesday 7 July 2020 | 10:00 a.m. – 11:00 a.m.

Ang Weina (Moderator)National Global Employer Services LeaderDeloitteEmail : [email protected]

Chee Ying ChengTax Executive Director – Global Employer ServicesDeloitteEmail : [email protected]

Mark Nicholas TeohExecutive Director – ConsultingDeloitteEmail : [email protected]

Datuk Jory LeongJoint Managing PartnerIza Ng Yeoh & KitEmail : [email protected]

Leonard WooExecutive Director – Financial Advisory (Valuationand Modeling)DeloitteEmail : [email protected]

Izzad ShamsudinPartner – Audit & Assurance (Advisory Services)DeloitteEmail : [email protected]

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