Eskom’s mischievious backdated share options

Eskom has been quietly backdating share options to qualifying executives of the parastatal without so much as even a cursory note in the company’s annual financial statements.

This came to light following a Moneyweb investigation into the long-term share incentives awarded to erstwhile CEO Brian Molefe and CFO Anoj Singh.

Eskom has been using a long-term incentive scheme for a number of years as a means of retaining senior executives and incentivising them to achieve a range of financial and non-financial targets.

How it works

Eskom’s long-term share incentive scheme is essentially a phantom share scheme as the executives never take ownership of the shares, which belong to government. The operation is quite straightforward. On the first day of each financial year, April 1, the group awards executives belonging to the executive committee with a number of shares nominally priced at R1 per share. The value of the shares escalates each year at money market-related rates, so that at the end of the three-year term the value of the shares, presumably, has more or less kept up with inflation.

The shares vest on the last day of the financial year three years later, and based on the number of targets that have been met, are paid out in cash to executives. It is a classic example of a “phantom share scheme” because the executives never take ownership of the shares.

As per the latest financial statements to March 2017, Eskom collectively awarded 37 million shares on April 1 2016, which will vest on March 31 2019. Based on a vesting price of R1.26 per share and the assumption that 50% of targets will be met, Eskom will expect to pay out R18.5 million to qualifying executives. The 50% assumption is a reasonable figure given that for the last two years, a number of shares that were determined to have vested by the board stood at 44.42% (2017) and 34.48% (2016) respectively.

But the annual report states very clearly, “The vesting of the award performance shares is also dependent on the scheme participant remaining in Eskom’s employment throughout the vesting period. The award lapses if employment ceases during the vesting period (other than for permitted reasons)”.

The curious case of Brian Molefe

Enter Brian Molefe. As group CEO who joined Eskom in an acting capacity on April 20 2015, he was initially awarded 7.5 million shares, along with Anoj Singh, who received 3.8 million shares. In both cases, the share awards were backdated to the first of April that year despite both only joining in a permanent capacity on September 25, almost halfway through the financial year.

For some or other reason, Eskom decided to top-up these offerings during the 2017 financial year by awarding and backdating a further 3.2 and 2.58 million shares respectively for the two executives, effective April 1 2015. This was something that was declared in a microscopic footnote to the annual financial statements.

Pg 107 of the 2017 Eskom Annual Financial Statements

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But even stranger was the next footnote: “Mr Molefe qualifies for the grants VESTED in 2018 and 2019 based on the terms of the long-term incentive scheme.” Why, after clearly indicating that shares had been awarded to Molefe in April 2015 and 2016, would they say something like that? Note the wording – it’s not shares awarded, it is shares vesting. In other words, after acknowledging Molefe had left the employ of the company, Eskom seems to be indicating he would be entitled to the share awards regardless.

In response to Moneyweb questions, Eskom said: “It is correct that a participant must be in Eskom’s service to qualify for an award and Mr Molefe was employed by Eskom at the time that the share awards were issued. Payments against these awards, however, will be subject to the impending court case ruling.”

Molefe took early retirement in December 2016. The board then rescinded this decision in May of this year and he was reinstated as group CEO. Following a massive public outcry, this decision was rescinded and Molefe’s tenure was terminated, a matter he is now arguing in the labour court. But this still doesn’t explain why the company stated he would qualify for these shares in 2018 and 2019 (see table below). And it’s a material sentence. By stating that Molefe qualifies for the shares vesting in 2018 and 2019, it adds a possible R26 million to his bottom line and probably R13 million if 50% of the targets are met.

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But the generous backdating of options was not something that was unique to Molefe and Singh. It was something that was generously awarded to the whole executive committee.

In the 2015 Annual Financial Statement, Eskom decided not to award any long-term shares to the executive committee for April 1 2014. It did not state why this was so. But perhaps the company considered it a little bit rich to be awarding “long-term” bonuses when it couldn’t keep the lights on. (For context, Eskom reinstated rotational load shedding on March 6 2014, but the small matter of electricity supply didn’t seem to stop the company from vesting and paying out shares amounting to R16.1 million in the same month).

This, however, didn’t stop the executives from getting what they were due. After the storm passed and Eskom began to get to grips with its supply challenges, the company backdated the relatively paltry amount of 12.3 million shares for April 1 2014. Let’s just be clear: there was no note mentioning the backdating. The amounts for 2014 were just included as comparative figures for the 2015 numbers. When we inquired as to why this was so, Eskom stated: “Due to uncertainty regarding the Eskom LTI scheme, the shares for April 1 2014 were issued late during the 2016 financial year.”

Phantom share schemes like this one, and their more popular counterpart in the private sector, share options, are, in my opinion, a pernicious evil. They create asymmetric outcomes that misalign the interests of shareholders (in Eskom’s case, the South African taxpayer) with the incentives of executives who carry limited personal risk yet seem to only enjoy financial upside. Perhaps, as minister Gigaba considers what needs to be done with respect to governance at state-owned entities, he should heed the wisdom of Nassim Taleb and require executives to be personally financially liable for financial and other failures that plague these ailing institutions. With some so-called “skin in the game” the outcomes might begin to change.

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