Incentivising Profitable, Not Unhealthy or Fat Growth in the Middle East Region

Do Long Term Incentives really work to the benefit of shareholders in the Middle East and North Africa region? The argument goes that in order to be globally competitive for the brightest and best people we need to offer an executive reward package commensurate with practices in North America, Western Europe, and South East Asia. A Long Term Incentive Plan (LTIP) is a necessary component. Is this a fact or fallacy?

Here is the reality. Executive compensation plans have become festooned with tax gimmicks in many Western countries with complex tax regimes. When you consider roles in Dubai, Bahrain, Doha or Riyadh, is the argument in favour so obvious? Indeed in periods of inflation throughout the region, these arrangements can impede responsible decisions. Over the past forty years, there are many examples where published accounts have disguised economic reality. Inventory profits and reduced depreciation are a function of inflation, not increased productivity. Yet management has little incentive to correct this anomaly, lest they undermine the value of the LTIP bonus.

OK, so assuming that there are organisations, who are not dissuaded by this argument, what are the lessons that they need to apply and adjust in their own organisations?

Focus on Four Performance Measures for Top Management

  1. Capital Allocation. Actual vs. expected return on investment, and actual vs. return and profitability of the entire organisation.
  2. People Performance. We are talking about the expected versus the actual results of developing and appointing key people into roles to support of the growth of the organisation. This judgement lean more towards art, than science but it can be measured.
  3. Innovation Performance. Let us be clear. We are not talking about solving problems or idea creation. We are talking about the expected versus actual results of applying new ideas or approaches in search of profitable growth.
  4. Strategy Performance. We are referring to the process of investing resources to realise a vision of the future. The measurement is actual versus expected results. Did our strategy provide the shortest path to our desired outcomes? Was the premise made on the right environmental factors? Were the goals the right ones for the organisation?

Correctly Decipher between Actual vs Perceived Business Performance

One of the biggest failures of LTIP arrangements is their reliance on reported "earnings per share" to determine how well the business is doing. Earnings per share masquerades a whole host of sins, yet analysts, investors and top management readily fall back on it as the "ultimate" performance measurement. It really is a measurement of corporate performance after tax deductible items are taken out. The correct measurement of business performance is "Return on Assets" or "Return on Capital". Since the intent with the incentive arrangement is to positively stimulate the economic performance of a business, reported earnings per share needs to be adjusted for four charges:

  1. Future Cash Funding. The difference between current revenues minus future cash needs (including servicing debt).
  2. The Current Cost of Capital (earnings need to be adjusted to today's borrowing costs, not the past costs when those rates may have been lower)
  3. The Growth Risks. The risks of foreseen and unforeseen factors e.g. cyclical factors, increased competition etc.)
  4. The future needs of the business. The earnings per share needs to be adjusted to take out the investment required to maintain the firm's market position or technological advantage over its' competitors.

The point with any incentive is that it must stimulate the right behaviour as well as the right results. Money, only works effectively, where the interests of all parties are correctly aligned and performance is measured on what matters.

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