Performance rights: They can be handed out like a blank cheque, but here’s what investors need to know

Many investors will have heard of the term ‘performance rights’, but may not know what they are. Although these are intangible assets, they could be the greatest incentive for a company’s directors to steer it in the right direction.

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What are Performance rights?

We encourage investors to read our earlier article about stock options for some background understanding. Because performance rights are similar in many aspects. Stock options give you the right to buy or sell shares of a company’s stock at a certain price. An option gives shareholders the right to purchase (or sell) shares of stocks in a predetermined time frame once that option is exercised.

The carrot is that the share price may be a lot higher than the option price so you can make a good profit on them! However, the reverse could easily be true – the company’s share price could be lower and there would consequently be no point in exercising the option.

Now, back to performance rights. These are similar to options but are generally only issued by a company to directors and/or senior management. Owners of performance rights have the right to buy shares in the future. But this is typically a ‘free’ share, in the sense that they don’t have to cough up cash. The right is subject to meeting certain hurdles that the company has set – such as a particular share price, EPS level or achieving a certain commercial milestone.

What is the point of knowing about performance rights?

When it comes to AGM season, you may well be voting on whether or not to give directors performance rights. You should know what you are voting on and know enough to make an informed decision. Unfortunatly, this is rarely the case and is often given with little consideration. This is unless of course the company has done poorly, but in which case it would be a rare company to have the temerity to still issue performance rights to underperforming management.

Bad companies aside, we think the only downside to approving the issuing of performance rights to directors would be the dilution if these shares get issued. But this would depend on the percentage of ordinary shares that the performance rights awarded would consist of. And of course, if the company’s share price rises substantially, the dilution caused would be a small price for the profits made.

A resolution may be tied up with options and/or the free granting of shares with no strings attached (in other words, just handed to them without them having to cough up a cent in cash). Beyond considering how to vote at an AGM, we would encourage investors to view recent 3Y notices (Directors Interest Notices). There they will be able to know how many shares, performance rights and options are already held by directors. And thereby, how incentivised they are to deliver for their investors.

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