State-owned Assets Intelligence | Innovation of long-term equity incentives and diversified incentive mechanisms to promote high-quality development under the new quality productivity
2024-08-08
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Looking back at 2023, my country's economy is in the post-epidemic economic recovery stage. Although it faces severe challenges, it has generally shown a positive trend of recovery. The research results of new quality productivity represented by modern industrial system and scientific and technological innovation continue to emerge. Different from "flooding" and short-term strong stimulus, the country insists on moving forward steadily in achieving high-quality development. In 2024, my country's economy still faces the current situation of coexistence of opportunities and challenges. As a key node for the realization of the goals and tasks of the "14th Five-Year Plan", it is still necessary to continuously accumulate endogenous power with new quality productivity as the core, and continue to unswervingly adhere to the goal of high-quality development.
At the Second Session of the 14th National Committee of the Chinese People's Political Consultative Conference [1], the country further clarified the goal of modern development of traditional industries and new quality productivity, that is, "grasping both ends with both hands and making both ends strong", strengthening basic research and applied basic research, fighting hard to overcome key core technologies, and cultivating new momentum for the development of new quality productivity.
As the "backbone" of the national economy, state-owned enterprises shoulder important missions and arduous tasks in the process of developing new productivity. At present, state-owned enterprises need to improve the innovation system, enhance innovation capabilities, stimulate innovation vitality, promote the deep integration of the industrial chain and innovation chain, and enhance the original technology demand traction, source supply, resource allocation, and transformation and application capabilities; through layout optimization and structural adjustment, promote the concentration of state-owned capital in forward-looking strategic emerging industries and future industries, and continuously improve the competitiveness, innovation, control, influence, and risk resistance of the state-owned economy.
As an important part of the national economy, private enterprises also play an important role in the process of developing new productivity. We must fully implement the opinions and supporting measures to promote the development and growth of the private economy, actively support entrepreneurs to focus on innovative development, dare to take risks and invest [2], greatly activate the development potential of private enterprises, and thus strengthen the new productivity driving force of the country's overall economic development and the growth attributes of high-quality development, and promote the country to a new level.
In the context of the country advocating the use of new quality productivity to achieve high-quality development, there is an urgent need for a large number of top innovative talents to provide solid talent support, so enterprises urgently need to build a high-quality workforce to lay a solid foundation for development. The 2024 Government Work Report [3] proposed the task of "cultivating and making good use of talents in all aspects" and emphasized "accelerating the establishment of a talent evaluation system oriented towards innovative value, ability and contribution, and optimizing the commendation and reward system". The talent evaluation system aims to provide a scientific basis for human resource management decisions such as promotion and incentives by systematically measuring and evaluating the ability and quality of talents, so as to screen out strategic talents who can create new quality productivity and application-oriented talents who can master new quality production materials for use by enterprises [4]. At the same time, a corresponding talent reward system should also be established. Long-term equity incentives recognize the important human capital value of employees to enterprises and link their personal interests with enterprise development. With the organic combination of talent evaluation system and long-term incentive mechanism, the two promote each other in helping enterprises to develop in the long term, and jointly commit to enhancing the value of talents, promoting enterprises to create more new quality productivity, and maintaining high-quality development.
Based on the equity incentives of 20 Hong Kong-listed companies in the next-generation information technology industry[6] that issued long-term equity incentives for central enterprises and listed companies that match Listing Rule 18C during the period from 2020 to 2023, EY[5] will discuss with you the long-term equity incentive trends and innovative insights into diversified incentive mechanisms to promote high-quality development under the new productivity:
Part I: Innovate and implement scientific policies - Research on long-term equity incentive mechanism and trend insights of listed companies controlled by central enterprises
Figure 1: Industry distribution of sample listed companies controlled by central enterprises[7]
Combined with the major favorable policies of the "Notice on Issuance" (hereinafter referred to as "Document No. 178") issued by the State-owned Assets Supervision and Administration Commission of the State Council, it effectively regulates and guides the implementation of long-term equity incentive plans for listed companies controlled by central enterprises, further activates the endogenous driving force of enterprises, and contributes to the high-quality development of enterprises. EY surveyed 99 listed companies controlled by central enterprises (hereinafter referred to as "listed companies" or "companies") that issued long-term equity incentive draft announcements from 2020 to 2023, covering domestic and foreign capital markets (A shares and Hong Kong stocks) and 23 industries. Among them, the most disclosed was the computer industry (12 cases) dominated by new productivity factors such as data and computing power, highlighting the high attention paid to talent incentives. Combined with the long-term equity incentive model, EY conducted a detailed interpretation from eight dimensions, including incentive objects, incentive tools, incentive amounts, equity sources, incentive pricing, rhythm arrangements, performance linkage and exit mechanisms, as follows:
Figure 2: Insights into key long-term equity incentives for central SOE-controlled listed companies
1. Incentive objects: Reduce quantity and improve quality, focus on core incentives
Figure 3: Statistics on the scope of incentive recipients of listed companies controlled by central enterprises[8]
In the development stage of new quality productivity, higher-quality workers are the first element of new quality productivity[9], and most of them are leading talents or senior managers who master core knowledge in the enterprise. Ernst & Young's survey found that the targets of long-term equity incentives for listed companies controlled by central enterprises are more focused on company directors, senior managers, and management, technical and business backbones who have a direct impact on the company's operating performance and sustainable development. The median value of the proportion of incentive targets to the total number of company employees is 5.87%, and the average value is 8.09%. From the perspective of industry distribution, industries with a high proportion of incentive targets also have obvious "new quality productivity" characteristics, especially the information industry represented by computers, with the median value ranging from 11% to 15%.
2. Tool selection: Restricted stocks are preferred, and innovative tools are introduced
Figure 4: Statistics on the use of incentive tools by listed companies controlled by central enterprises
Ernst & Young's survey found that central enterprises holding listed companies mainly use restricted stocks as an incentive tool, accounting for 79.80% of the sample. This is mainly due to the fact that restricted stocks have a good balance of constraints and incentives, that is, the stocks cannot be granted in the market during the restricted period and the restrictions can only be lifted when the agreed performance conditions are met. It not only has a relatively long-term talent binding effect, but also encourages the incentive targets to be responsible for performance.
At the same time, with the introduction of new quality productivity requirements, the high-quality development of state-owned enterprises has entered a new journey, and the demand for building a high-quality talent system and supporting incentive measures has become increasingly strong. Ernst & Young's research found that under the framework of the policy requirements of long-term equity incentive tools, there are many companies that explore and introduce innovative incentive tools to achieve innovation and flexibility in the formulation and implementation of incentive plans, better attract and motivate outstanding talents, and achieve the purpose of improving the competitiveness and market position of enterprises. For example, a central enterprise holding listed company listed on the Science and Technology Innovation Board innovatively adopted the second type of restricted stock as an incentive tool. The main feature of the second type of restricted stock is that there is no need to make advance capital contributions. After meeting the benefit conditions, the incentive object will invest in the company's stock at the grant price, and it can be freely traded after the restricted period. If the company does not set a restricted period, the incentive object can sell the shares in accordance with relevant regulations after completing the share registration. In fact, it has made innovative designs in terms of the scope of incentive objects, incentive amount, grant price, and investment timing, which not only strengthens the long-term incentive effect, but also improves the incentive perception.
3. Incentive amount: The proportion of the total incentive amount is above 1%, and more than half of it is set as a reserved amount
Figure 5: Statistics on long-term equity incentive quotas of central enterprises holding listed companies
EY's research found that the median value of the total amount of incentives as a proportion of the company's total share capital at the time of the draft announcement was 1.30%, and the average was 1.73%; 66% of the companies (65 companies) implemented a total amount greater than 1% for the first time, most of which were small and medium-sized listed companies, but also included 9 companies with a market value of more than 50 billion, following the relaxed policy of increasing the incentive amount to 3% for small and medium-sized market value and technology-innovative listed companies to match the actual development needs of such companies.
Figure 6: Statistics on the amount reserved for long-term equity incentives implemented by listed companies controlled by central enterprises
Regarding the amount of reserved quotas, 67% of companies chose to set a reserved quota, of which 11% chose to set the maximum reserved quota, that is, to reserve 20% for attracting and motivating new core backbone personnel. Combined with the country's task goal of continuing to work hard to improve the talent development environment in 2024, it can be seen that central enterprises and listed companies have not relaxed their continuous incentives for talents.
4. Equity source: the mainstream is private placement
Ernst & Young's research found that private placement is still the main source of long-term equity incentives, accounting for 82%, and 10 companies use secondary market repurchase as a source of stock. Private placement has become the mainstream choice because of its convenience, that is, secondary market repurchase can only be used as a source of equity if it meets the conditions of "not exceeding 5% of the total shares" and "holding period of 3 years", while private placement has no such restrictions; on the other hand, private placement is a joint dilution of shares by all shareholders, and can reduce the company's financial pressure to a certain extent.
Figure 7: Statistics on the sources of long-term equity incentives implemented by central enterprises holding listed companies[10]
5. Incentive pricing: Most people prefer 50% off pricing, which is more incentive-based
Ernst & Young's research found that among the companies that use restricted stocks, 55% chose to grant the stocks at a price not less than 50% of the fair market value, reflecting the company's willingness to share the dividends of high-quality development with the incentive targets; 44% of the companies chose to grant the stocks at a price not less than 60% of the fair market value, of which 20% of the companies chose to grant the stocks at a price not less than 60% of the fair market value due to the stock price falling below the net assets, and the remaining companies made their own choices. Only 1% of the companies chose to grant the stocks at a price not less than 70% of the fair market value.
Figure 8: Statistics on the price of long-term equity incentives granted to listed companies controlled by central enterprises
6. Rhythm arrangement: The "2+3" ownership model becomes the mainstream choice
Figure 9: Statistics on incentive rhythm of listed companies controlled by central enterprises
Ernst & Young's survey found that 35% of the companies announced plans with a validity period of 60 months, and 53% of the companies planned a validity period of 72 months. Among them, 98% of the companies chose the "2+3" model, that is, the 2-year waiting period is divided into 3 years of uniform vesting, strictly following the policy requirements of "the exercise restriction period/restricted sale period shall not be less than 2 years (24 months) in principle, and the exercise validity period/unlocking period shall not be less than 3 years". In terms of rhythm arrangement, 84% of the companies follow the policy requirements of "uniformly taking effect in batches during the exercise validity period/unlocking period". Some listed companies are more strict on the basis of the policy, and vest according to the rhythm of 3:3:4 and 2:3:5. At the same time, 12% of listed companies have broken the policy regulations and vested according to the rhythm of 4:3:3.
7. Performance linkage: Linking performance indicators when granting or vesting, and setting indicators to drive performance achievement
Figure 10: Statistics on the setting of conditions for granting central enterprises to listed companies
EY's research found that company performance indicators are mainly used at the time of grant and vesting. 45% of companies have set performance conditions for granting, and the associated performance indicators are basically consistent with the performance conditions for vesting.
Figure 11: Statistics on the setting of vesting conditions for listed companies controlled by central enterprises
In terms of attribution indicator setting, in order to more accurately reflect the business conditions and value creation capabilities of enterprises, return on net assets, net profit growth rate and EVA[11] are relatively easy to calculate and understand indicators and are widely used by most central enterprises listed companies, with a usage frequency of 84%, 65% and 75% respectively. In addition, in terms of operational quality indicators, 10% of enterprises have innovated indicators around the central enterprise assessment system, the main business characteristics of listed companies and the actual operation and management of the company, that is, setting "fourth category assessment indicators", such as R&D investment intensity, main business labor productivity, main business product market share, special product scale proportion, annual accounts receivable turnover rate, non-related transaction income proportion, group assessment indicator completion value/completion rate linkage unlocking ratio, etc., which can not only reflect the company's strategic planning and management characteristics, but also make the attribution conditions more suitable for the new company's business development, and further strengthen the orientation of high-quality development.
Figure 12: Comparison of the vesting conditions of listed companies controlled by central enterprises
Ernst & Young's survey found that when selecting the benchmarking level for attribution conditions, 97% of companies chose to benchmark the 75th percentile of the target company or the industry average, and only 3% of companies benchmarked some indicators against the median level, reflecting a high degree of response to policy requirements. We have seen that under the trend of high-quality development, the state requires state-owned enterprises to continuously align with the high level of the industry, achieve steady progress and key breakthroughs, and at the same time, in combination with the actual situation of the industry in which the enterprise is located, carry out orderly promotion and high-quality implementation according to local conditions, truly focus on enterprise development, and achieve steady progress.
8. Handling of special circumstances: overall strict exit arrangements, with moderate innovation in a few cases based on actual conditions
Figure 13: Statistics on “innovation” in handling special situations
Ernst & Young's research found that while the overall policy requirement of "employees who leave the company cannot exercise their rights if they have not reached the time limit for exercise and the performance evaluation conditions" is followed, 9% of companies have made moderate innovations in the exit mechanism, such as flexibly stipulating that if the unlocking/vesting time is not reached in the year of resignation, the rights will be redeemed according to the tenure limit of the corresponding performance evaluation year, depending on the individual's contribution, and no redemption will be made in subsequent years. This move can avoid the "one-size-fits-all" approach of completely denying employees' historical contributions, and ensure the flexibility of the incentive mechanism.
Part II: A hundred boats compete in the current, and the one who paddles hard will be the first to come out on top - Research on the long-term equity incentive mechanism and trend insights of Hong Kong-listed companies in the new generation of information technology industry before listing
In conjunction with Chapter 18C of the Hong Kong Stock Exchange's Main Board Listing Rules, EY has targeted listed companies in specialized technology industries such as "new generation information technology" and, based on a deep understanding of the basic connotation that "the strength of the technological attributes of production tools is a significant indicator of identifying new quality productivity[12]", we have focused on studying 20 Hong Kong-listed companies in the new generation information technology industry that match Chapter 18C of the Listing Rules, and have conducted a detailed interpretation of the trends of their pre-IPO equity incentive plans from four dimensions: incentive targets, incentive tools, incentive amounts, and rhythm arrangements. The details are as follows:
Figure 14: Insights into the trend of long-term equity incentives before listing in Hong Kong-listed companies in the new generation of information technology industry
1. Incentive targets: Overall incentives focus on the core, and senior executives are fully covered
Figure 15: Statistics on the scope of incentive targets of Hong Kong-listed companies in the new generation information technology industry [13]
Labor materials with higher technological content serve as the driving force of new-quality productivity[14], providing a solid foundation for high-quality development. According to Ernst & Young’s survey, the median ratio of the number of employees in the new generation of information technology industry to the total number of employees is 14.89%, and the average is 16.75%. In terms of the incentive targets, there is a clear focus on incentives for executives at the director level and above, and SVP/VP and above senior management personnel have achieved comprehensive incentives. It can be seen that core executives, as an important force for the company’s high-quality development, are particularly reflected in long-term equity incentives.
2. Incentive tools: Combined incentives become the mainstream, driving performance creation
Figure 16: Statistics on the adoption of single/combination incentive tools by Hong Kong-listed companies in the new generation information technology industry
EY's research found that 40% of companies choose to use a combination of incentive tools such as "stock options + restricted stocks/restricted stock units" for incentives. In view of the current overall economic environment and the capital market being in a stage of continuous fluctuations and a recovery in transactions, stock options are used to guide "incremental" value creation and sharing, and restricted stocks/restricted stock units are used to provide special incentives based on performance or long-term interest binding for talents, so as to meet the multi-level and diversified incentive demands of employees. Under the current national call for vigorously developing new quality productivity and continuously promoting high-quality development, the new generation of information technology industry, which uses new quality productivity as its main production tool, is in a stage of vigorous development. By effectively leading employees to create incremental performance, it can push new quality productivity to a new level.
3. Incentive amount: The total amount of incentives before listing is about 12%, providing effective space for talent incentives
Figure 17: Statistics on incentive quotas for Hong Kong-listed companies in the new generation information technology industry
According to Ernst & Young's research, the median incentive amount of Hong Kong-listed companies in the new generation of information technology industry before listing was 12.25%, and the median incentive amount after listing was 9.85% after taking into account the impact of listing dilution. In line with the country's demand for building a high-quality talent system and the requirements for the establishment of supporting incentive measures, listed companies with new-quality productivity as their core competitiveness generally have a strong demand for long-term equity incentives, resulting in a considerable total amount of incentives, reflecting a firm determination to build a talent team.
4. The vesting rhythm is diverse, with "4-year cycle" and "uniform vesting" being the most common choices.
Figure 18: Statistics on incentive rhythm of Hong Kong-listed companies in the new generation information technology industry
EY's research found that Hong Kong-listed companies in the new generation of information technology industry mostly adopt a four-year vesting cycle, and the vesting rhythm is diverse. 70% of the sample companies choose a uniform vesting rhythm, and some companies set up innovative milestone vesting rhythms in order to gradually achieve the company's performance/capitalization goals, such as "a small proportion of vesting when the company achieves a listing milestone + a specific proportion of vesting after 2 years", "a one-time vesting based on a milestone point determined by the company", etc., to promote the company's high-quality development and enable the development of new quality productivity with better long-term incentives.
Conclusion
In summary, after studying state-owned enterprises represented by central enterprises holding listed companies and enterprises represented by the new generation of information technology industry that take new quality productivity as their core competitiveness, EY found that the innovation of long-term equity incentives and diversified incentive mechanisms to promote high-quality development under the new quality productivity presents the following characteristics: overall compliance with policy requirements, while flexible innovation combined with the actual situation and development requirements of the enterprise, demonstrating innovation, sustainability, growth and constraints. As the country puts forward the requirements of new quality productivity, high-quality development has entered a new journey. In order to achieve the key tasks of improving the core competitiveness of enterprises and enhancing core functions, it is necessary to fully mobilize the enthusiasm of core talents in key positions of enterprises and promote the strengthening, optimization and expansion of state-owned capital and private capital. This also means that more and more companies expect to use long-term equity incentives to effectively incentivize and constrain the interest mechanism, boost corporate performance, and meet the reform goals. The EY team's research found that as of 2023, 91% of the first batch of listed companies that announced the exercise of options had exceeded their organizational performance targets. Long-term equity incentives, as one of the key boosters, encourage companies to benchmark performance appraisals with incentive levels as an important means to implement incentive norms, stimulate employee creativity, and actively align themselves with first-class companies with high-quality development, effectively stimulating the company's endogenous value growth.
Figure 19: EY’s long-term equity incentive methodology
Figure 20: EY high-quality model for organizational development in the new quality productivity environment
In the context of new productivity, combined with the overall requirements of the country's high-quality development, central enterprises, listed state-owned enterprises, and enterprises in industries related to new productivity should first make full use of and comply with relevant policies when formulating and implementing long-term equity incentive plans. At the same time, they should also comprehensively consider the characteristics of the industry and internal needs of the enterprise, match appropriate incentive tools with the help of Ernst & Young's long-term equity incentive methodology model, select incentive targets by focusing on core talents, and ensure that the total incentive amount is considerable and a moderate amount is reserved. In addition, they should explore innovative space in the selection of granting and attributing performance indicators, set up diversified indicators that are in line with the actual situation of the enterprise and can promote the growth rate of profits, flexibly use the long-term equity incentive mechanism, and better contribute to the development of the enterprise. With the help of Ernst & Young's high-quality model of organizational development under the new normal environment, the enterprise's organizational development model is optimized and upgraded to match the requirements of new productivity and the trend of high-quality development, helping enterprises to carry out integrated organizational reform and upgrading from multiple dimensions such as organizational change, governance mechanism, equity structure, long-term incentives, and market value management, so as to truly achieve stability through progress, improve quality and efficiency, and comprehensively enhance the overall value of the enterprise.
Note:
[1] Reference: “On the development of new quality productivity, the General Secretary stressed this”
[2] Reference: 2024 Government Work Report
[3] Reference: 2024 Government Work Report
[4] Reference: “Applying the requirements of new quality productivity to accelerate the cultivation of top innovative talents”
[5] Refers to Ernst & Young (China) Consulting Co., Ltd., referred to as “Ernst & Young” in this article.
[6] As there are currently no companies listed under Chapter 18C, we use Hong Kong-listed companies in the software services industry and other industries in the Hang Seng Industry Classification as sample companies
[7] Domestic A-share listed companies are classified according to the industry classification of Tonghuashun, and Hong Kong-listed companies are classified according to the Hang Seng industry classification. The industry classification standards below are consistent with this. All charts and data used in this article are compiled and analyzed by the EY team based on public information such as the long-term equity incentive draft announcements issued by domestic A-share listed companies and the listing prospectuses issued by Hong Kong-listed companies.
[8] The total number of employees of the company is taken from the total number of employees of the company in the year when the incentive plan was announced.
[9] Reference: [Expert Opinion] Practical Path to Develop New Quality Productivity
[10] Statistics do not include sample companies that use stock appreciation rights as an incentive tool
[11] EVA refers to economic value added
[12] Reference: “The connotation, characteristics and development priorities of new quality productivity”
[13] The total number of employees of a company refers to the total number of employees disclosed in the company’s annual report in the year of listing.
[14] Reference: “The connotation, characteristics and development focus of new quality productivity”
This article is written for general informational purposes only and is not intended to be relied upon as accounting, tax, legal or other professional advice. Please consult your advisor for specific advice.
(This article comes from China Business Network)
