Goodwin (GDWN)

 

Big incentive for 75% share price gain

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Big incentive for 75% share price gain
High executive pay and convoluted schemes to pay it are widely criticised at larger firms. The practice is much more widespread than that.

First off, an apology for writing about Goodwin's (GDWN) incentive plan for the second time in three weeks. The company has clarified how much the share options could be worth and the strings that will mean some of the directors have to retain some shares for some time. I'd also like to tease out the wider implications of complicated Long Term Incentive Plans (LTIPs) for listed companies, and the economy because Goodwin was unusual in not having such a plan.

Goodwin's plan is likely to be voted through by the board at the AGM in October because the board owns a slim majority of the shares.

Crudely, the incentive could award Goodwin directors options on 1% of the company's share capital in less than three years' time if the share price reaches £35 (today it is around £20). The options would cost them a minimal amount to exercise and each director's award would be worth around £2.5 million*. The cost to shareholders would be an 8% dilution in their holdings. A small price to pay, perhaps, considering the share price would have risen about 70%.

Raising eyebrows

If Goodwin was a good investment before, on a purely financial basis the incentive scheme doesn't make Goodwin a bad investment now. But the potential size of the awards raises an eyebrow.

It would be better if the directors held the shares because that would be an enduring incentive to manage the company for the long-term. Goodwin tells me directors will be restricted from selling the shares they are awarded.

They will be allowed to sell a maximum of 33% a year in the five-year period following April 2019 when the award will be made, and the company will not introduce another Long Term Incentive Plan during that period.

I'd worry the directors would resort to manipulating profit to achieve a rise in the share priceThat means, if the scheme pays out in full, each director could receive a cash payment of £800,000 on the basis of only three years' share price performance (and matching sums in the following two years).

Spread over the three-year period it will take to earn the share options and the five years after, when the company won't start a new plan, very roughly the award could be worth £300,000 a year depending on what happens to the share price.

That's on top of the directors' pay, which ranged from just over £100,000 to just over £300,000 each for the executive chairman and managing director in 2015.

Usually I'd worry the directors would resort to manipulating profit to achieve a rise in the share price. It's easily done. Companies can buy back shares, which increases earnings per share.

They acquire other businesses, buying profit effectively, or slash investment to cut costs, which also boosts profit because profit is the difference between revenue and costs.

Profit at risk

Activity like this puts profit at risk further in the future if it worsens the company's financial position. Buying shares and businesses often requires borrowing, and borrowing is risky for a business, particularly if earnings don't live up to expectations, because it might not be able to pay the interest if profit slumps. Investment is an exercise in deferred gratification.

If you increase investment in the current year you reduce profit, but increase the potential to profit in future. If you cut investment, then the firm's prospects may be diminished.

Goodwin's strategy, investing long-term even if it hits profit turns off traders but attracts long-term investorsI'd be surprised if Goodwin stooped this low. The company has been built on investment. Deferring gratification has been its superpower for decades. The firm rightly boasts it has lifted Total Shareholder Return 14,000% over the last twenty years. Since the directors hold a majority of the shares already, they have the most to lose if ultimately they destroy value.

That said, the annual report shows a 61% cut in capital expenditure in the year to January 2016 and a 55% increase in borrowing. More than likely this is the inevitable consequence of a sharp drop in demand and relatively few opportunities to invest profitably.

Traders might view the remuneration scheme differently, anchoring on the potential gain. But Goodwin's strategy of investing for the long-term even if it hinders profit and dividend payments in the short-term has, by its own admission, deterred them and encouraged long-term investors to own Goodwin shares.

Refuge from money-grabbing

Goodwin has become something of a refuge offering protection from the financial engineering and manic deal-making listed companies are so often criticised for. Controlling shareholders prevent financial institutions and investment funds from encouraging short-termism so they can achieve their own performance benchmarks. Controlling shareholders often make better bedfellows for long-term investors than the investment funds that dominate the stockmarket.

Many people doing responsible and demanding jobs do not receive bonusesThis money grabbing view of the City and the influence it has on listed firms isn't just my view, it was a conclusion of the Kay Review, a government sponsored review in 2012 into whether the stockmarket was fit to encourage the development of globally competitive firms capable of earning sufficient returns to satisfy our pensions and other long-term financial goals.

Kay's conclusion regarding remuneration was that convoluted share option schemes establish the wrong incentives. Kay attacked the bonus culture in general:

We might ask why it is necessary or appropriate to pay bonuses to the directors of large companies at all.

Many people doing responsible and demanding jobs – cabinet ministers, judges, surgeons, research scientists – do not receive bonuses, and would be insulted by the suggestion that the prospect of bonuses would encourage them to perform their duties more conscientiously.

There are many criticisms of these professions, but rarely that they are not making the maximum effort. In all of these activities, successful performance is inherently rewarding, and the prospect of such a reward provides effective alignment of private and public interest.

Goodwin shows that investing in family-owned firms is not a panacea for the ills of capitalismAnd recommended:

Companies should structure directors' remuneration to relate incentives to sustainable long-term business performance. Long-term performance incentives should be provided only in the form of company shares to be held at least until after the executive has retired from the business.

ShareSoc, the UK Individual Shareholders' Society**, has its own ideas about how executive pay should be limited.

My blood isn't really boiling like the headline of my last article says, but regardless of the outcome at Goodwin, the company's incentive plan shows that investing in family-owned firms is not necessarily a panacea for the ills of capitalism.


*That's slightly less than the £3 million I calculated, but the target is also slightly lower than the £43 target I estimated. The difference is because Goodwin reinvested dividends in its calculations and I chose not to because I was lazy and a ballpark figure was enough.

**I'm a member.

Contact Richard Beddard by email: [email protected] or on Twitter: @RichardBeddard

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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