Key Points:

  • Designed to prevent improper stock option gains
  • Major issues related to equity incentives clarified

Incentive plans are programs established to give benefits to employees to reward them for improved commitment and performance and as a means of motivating their future performance. They are designed to supplement base pay and fringebenefits. Incentive plans are frequent and effective mechanisms China’s companies have used in the past year to retain their key employees and stimulate their performance.

China's securities regulator, the China Securities Regulatory Commission (“CSRC”), has announced new rules on incentive plans for listed companies: the Memoranda on Issues Regarding Equity Incentives No. 1 and No. 2, issued by the Supervision Department of the CSRC on May 6, 2008.

As incentives programs frequently include stock option plans, and the targets of those plans are key management officials who frequently derive high incomes from their plans, these rules constitute an effort to prevent those officials from reaping improper gains resulting from favorable timing.

For example, according to Memorandum No. 2, listed companies may not introduce share option schemes shortly before announcing major decisions. In addition, listed companies may not carry out major actions such as new stock issues, asset injections or bond offerings within 30 days after having announced an incentive plan and obtaining shareholder approval.

Likewise, companies are prohibited from introducing incentive plans during or within a 30-day period after the announcement and completion of major corporate decisions. In addition, the memoranda prohibit shareholders from directly awarding or transferring shares to the object of the incentive plan (mainly the management officials) as the source of share. Shares must be awarded via the public market, and the company must purchase them back and record them with CSRC before awarding them to the object of the incentive plan.

China’s media have reported that the CSRC's action was taken in response to recent attempts by several companies to introduce incentive plans immediately prior to disclosing positive corporate information. Certainly, the timely intervention of the CSRC will serve to benefit both listed companies and their shareholders. This would undoubtedly protect the interests of the minor shareholders.

On a related issue, the two Memoranda clarify major issues related to equity incentives. These include the following:

(i) Issues related to the withdrawal of incentive funds – i.e., the withdrawal of the incentive funds for the purpose of making the incentive plan must be carried out according to the laws, regulations and the Articles of Association and the Accounting Rules;

(ii) Shareholders and effective controllers becoming incentive targets. In principle, a shareholder or effective controller whose stocks occupy more than 5% of the total equity stocks of a joint stock limited company shall not become incentive targets, unless approval is passed via vote at a general shareholders’ meeting. Shareholders who become incentive targets shall not participate in voting on the matter in the meeting.

(iii) Discounts granted on restricted stocks and the qualifications of incentive targets. These are new clarifications on incentive plans. Restricted stock programs are designed to reward key management officials for meeting performance standards or serving a fixed term in a company. If the restricted stock is obtained from an additional amount listing, the pricing principle and the restricted stock terms should be in accordance with the Management Rule regarding the issuance of the securities of the listed company.

To summarize, rules concerning incentive plans for listed companies have been tightened to prevent key management officials from deriving improper gains arising from favorable timing and to protect the interests of the shareholders. At the same time, some issues related to incentive plans have been clarified to ensure the transparency of listed companies’ implementation of these plans. On a separate note, the issue of shareholders and effective controllers as possible incentive targets, which might motivate them to contribute more to a company, remains unaddressed.