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What's ahead for UAE employees: long term incentives?

Written by Sara Khoja and Bronwyn Colgan

At least four years on from the onset of global recession, the employment environment in the UAE has settled and the widespread terminations of a few years ago have passed. As the quiet summer period draws to an end, our focus turns to employment practices and what's on the horizon for UAE employers and employees.

As the employment arena continues to develop in the UAE, more and more employers are moving beyond labour law minimums in relation to employee entitlements and practices. Employers are increasingly raising the bar and looking to international best practice when determining employee rights and benefits, for example, in the areas of protection against discrimination, maternity/paternity leave, pensions and disciplinary and performance policies. The natural progression in this evolutionary process leads employers to offering employees equity based incentives.

The role of equity incentives

In order to maximise an employee's potential and input, companies need to encourage employees to work like they would if they were an investor in the business; "work like you own the company". Long term incentive plans help to align the interests of employees with the interests of investors. With the appropriate incentive mechanisms in place, companies can encourage increased returns for investors whilst providing long term remuneration strategies for employees.

As ever, companies continue to face the challenge of maximising employee input with minimum expenditure. Under a long term incentive plan, employees receive a financial reward based on the level of success of the employing company or the group parent company over a set period, typically three to five years.  If the company performs well and achieves the set targets, employees are rewarded in line with the company's success.  As employees are rewarded proportionate to the company's performance, these arrangements are attractive because of their cost-effectiveness.

The options

A long term incentive plan is often structured as a share option or some other right to acquire a share in a company at a future point in time.  Such arrangements can take the form of an award of free shares, nil-cost options (where there is no price to pay on the exercise of an option) or share appreciation rights.

Under a long term incentive plan employees are effectively given the opportunity to acquire, at a future point in time, a stake in the employing company or parent company at a discount or free of charge and, therefore, without assuming the financial risk.  For example, an employee may be granted a share option when the share price is AED 2.  If, after the vesting period the share price has risen to AED 5 and the employee exercises the option and sells the shares, there is a gain of AED 3 per share.  If the share price does not rise, the employee will not exercise the option and therefore will incur no loss.

There can be legal and practical difficulties in offering shares to employees locally under an incentive plan in the UAE.  The most obvious hurdles are the restrictions on foreign ownership in companies established "onshore" in the UAE and the inability of companies established "onshore" in the UAE to issue different classes of shares.  There may sometimes be an element of reluctance on the part of existing shareholders to allow employees to become shareholders.

However, incentive plans are extremely flexible and can be structured on a cash basis to replicate share-based plans (so-called "phantom" share schemes).  Rather than receiving shares, an employee receives the equivalent benefit in cash. Many locally based companies have chosen to operate their employee incentive arrangements in this way.

There are a number of advantages to cash-based plans in that they can be far simpler and are more cost effective to implement and operate. They also avoid dilution for shareholders and company law restrictions.  Under a cash-based plan, companies are able to achieve the same overall economic effect as they would under a share-based plan without giving away any ownership or control.  Cash-based plans can also be simpler for employees to understand and they avoid the complex rights and obligations that can arise with being a shareholder.

Considerations in plan design

In structuring a relevant and appropriate long term incentive plan for its employees, a company will ultimately need to determine:

  1. what it would be seeking to incentivise its employees to do;
  2. which financial measure (or combination of measures) would be the best indicator of the company's performance (for example, this might be net profit, return on equity or market share); and
  3. whether the company's shareholders are prepared to share with employees a proportion of the success the company achieves (as gauged by the chosen measure(s)).

A final word

As UAE employers continue to adopt global best practices, it seems inevitable that this trend will extend to areas of remuneration practice. Although employers who embrace equity based incentivisation as part of the remuneration package now can still be a step ahead of the game, it seems that it will be only a matter of time until equal incentives, particularly at management level, will form an integral part of the remuneration package in the UAE.

Should you have any questions in connection with this article or the legal issues it covers, please contact Sara Khoja or Bronwyn Colgan.