Treatment of employee equity incentives in listed company change of control transactions requires careful attention by directors. Addressed properly, the treatment is consistent with the directors’ recommendation on the transaction resulting in employees, the bidder and target shareholders all being treated fairly and appropriately. The alternative can disenfranchise employees, lead proxy advisors to question judgments made by directors and affect proxy advisor recommendations on the transaction, or even have value implications for all shareholders.
Three key things can help provide directors with maximum flexibility to decide the appropriate treatment in the circumstances and help ensure employees (and the bidder) are properly accommodated:
- Building flexibility and consistency into employee equity incentive plan terms from the outset to ensure directors retain the appropriate discretion to determine and implement outcomes in the event of any transaction
- In the face of any change of control transaction ensuring appropriate information is provided to the Board to help guide its decision on how to treat the incentives in the circumstances and guide associated negotiations with a bidder
- Clear communication with employees once a final decision has been made
At its core, a decision on the treatment of employee equity incentives is a matter of directors’ duties, informed by both what can be done and the Board’s assessment of what should be done in the circumstances.
In this article, we explore how to navigate what is sometimes one of the most sensitive and complex aspects of a listed company change of control transaction: employee equity incentive treatment, and how understanding market practice and the different considerations for Boards can support better decision making.
Build flexibility and consistency into plan terms
Drafting change of control provisions in equity incentive plans without knowing what form a change of control transaction may ultimately take necessarily requires the plan rules to provide appropriate flexibility. Drafted properly, the plans allow the Board to determine outcomes that cater to a variety of change of control scenarios. The key decision is for Boards is typically whether the incentives vest or not in the face of a control transaction and, if so, on what terms – eg whether they vest in part or in full. Best practice calls for outcomes to not be hardwired in plan documents, but rather for directors to have the discretion to decide outcomes on a case-by-case basis.
Proper drafting and disclosure also gives employees enough information to understand what could happen to their equity incentives on a change of control. In addition to employee offer documents, disclosure regarding treatment on a change of control should be included in notices of AGMs when seeking approval for CEO equity grants, and also in remuneration reports in relation to KMP’s remuneration arrangements.
Sufficient flexibility in the plan rules and complete and accurate disclosures can also mean that an ASX waiver is not needed at the time of any change of control transaction to accommodate the Board’s decision on vesting or lapse. Relevantly, the ASX takes the view that a waiver is not needed where a Board exercises an existing discretion under the plan terms to vest performance rights on a change of control.
The flexibility can extend beyond decisions on vesting or exercise to how equity incentives in the form of rights or options are settled: in cash, rather than shares. While also a matter for negotiation with a bidder, Board discretion to settle in cash is now increasingly common (appreciating that in certain cases a bidder might prefer a ‘rollover’ of incentives to ensure key management are retained). A cash out option can be particularly useful where the change of control transaction is for cash, not scrip, and where regulatory requirements applicable in certain sectors require deferral of a portion of variable remuneration as an ongoing BAU matter - e.g. as is the case for financial services entities caught by the Financial Accountability Regime (FAR) or APRA Prudential Standard CPS 511 Remuneration (CPS 511)). The remuneration requirements under these regimes are relatively new and present unique and complex challenges for target Boards and bidders to navigate in change of control transactions.
Where companies have multiple equity incentive plans in place, consistency of plan terms dealing with changes of control can also help to simplify the Board’s later decision making, and support fair and consistent treatment and clear communication to employees. Reviewing existing plan documents and making amendments if necessary is often best done outside the context of a live transaction.
Finally, good ‘hygiene’ when it comes to employee equity plans will limit surprises down the track. Having up-to-date and well-maintained records of all grants, vesting dates, and plan terms is critical to ensure decisions are being made based on the right information.
Prepare the Board to reach an in-principle view on employee equity treatment under the change of control transaction
Early in-principle decisions regarding employee equity can help bidder negotiations, give employees clarity and leave room to adjust as the deal develops. They also support retention planning and broader execution. On the other hand, committing too early to an outcome can be counterproductive (which we discuss later in this article).
When exercising their discretion, Boards will need to consider a range of factors. These may include (but are not limited to):
(a) The nature of the employee equity plans
The Board’s primary focus should remain on what is permitted by the plan terms as well as the spirit and purpose underlying why the equity incentives were granted and what conditions on vesting are attached. The question should not solely be what other Boards have done on other deals but rather what outcome is justified for the employee equity incentives in this deal, considering the nature of the transaction, the impact if any on the bidder’s offer and the company’s specific circumstances.
(b) Market practice
While market practice is relevant, it should not constrain or dictate the Board’s discretion. However, it is a useful yardstick against which third parties might benchmark the Board’s approach to the exercise of discretion.
Looking at the data for select Australian schemes of arrangement over $500m during the period 2010 – August 2025, and focussing on rights-based incentives, it appears:
- (full vesting of rights) rights were fully vested in about 57% of transactions. By far the most common approach involved rights being fully vested on an accelerated basis (ie without regard to any applicable performance hurdles), with target shares being provided to employees which then participated in the scheme. A smaller proportion involved cancellation of rights for value, typically measured by reference to the scheme price or a similar valuation measure e.g. volume weighted average price in the 10 days before scheme implementation;
- (partial vesting of rights) partial vesting was the next most common approach, involving either the conversion of a portion of performance rights into shares (seen in ~24% of transactions), or the board exercising its discretion to cancel rights for consideration equal to an independent value calculated using e.g. the Black Scholes model or equivalent (~3% of transactions). Inherent in this approach is a decision by the Board to assess vesting outcomes in light of the extent to which the rights would otherwise be likely to vest; and
- (no vesting of rights) albeit rare, in some transactions rights were not vested at all (~3% of transactions). This only occurred where the rights were out-of-the-money options and the exercise price was above the per share price offered under the scheme.
The remaining ~13% of transactions involved a combination of the above.
As can be seen above, market practice varies, further supporting the view that a detailed assessment is needed in each case.
(c) Commercial and governance rationale for exercise of discretion
Directors must act in good faith, for a proper purpose and with reasonable care. In deciding on any vesting outcome, Boards must be mindful of these duties.
In making their decision, Boards should consider what would likely have happened in the ordinary course, and test for windfall outcomes, employee fairness, shareholder and market perception, bidder retention objectives for key personnel and the impact if any on a bidder’s bid price. Allowing for full vesting by a target with a significant portion of its capital subject to employee options/rights could result in a lower price per share being offered for all shareholders under the control transaction.
Vesting may be justified to ensure continued employment and motivation of key executives and maintain stability. Boards should also consider the likelihood of whether the employee equity incentives would have otherwise vested, including where an agreed control transaction date was announced close to or shortly after performance testing dates.
If the deal proceeds by scheme, the treatment will be disclosed in the scheme booklet (equivalent disclosure in takeover materials would also be included). Boards should record their reasoning carefully in minutes and papers, even if those reasons are not fully disclosed publicly.
(d) Legal and regulatory overlay
In making any decision, Boards should also be mindful of other legal and regulatory requirements including the application in the circumstances of both the termination benefit provisions in the Corporations Act and ASX Listing Rules.
Additionally, if the target is APRA-regulated, Boards should also consider the application of CPS 511 and the FAR, which contain deferral and malus/clawback requirements for variable remuneration. These deferred remuneration requirements may limit the ability of Boards to exercise their discretion to immediately vest or cash out equity incentives in the manner they otherwise would – ultimately this is a matter that should be determined in consultation with the bidder to ensure ongoing compliance with the requirements post transaction.
(e) Implementation and tax issues
Boards should also seek to consider any implementation and tax issues early.
From a tax perspective, a critical consideration is whether what is proposed for the employee equity incentives could trigger a taxing point for employees. This is particularly important where employees are not being ‘cashed out’ (eg they might receive ‘rollover’ incentives from the bidder instead), as they may not be put in funds to allow them to meet their tax liabilities if they do arise.
Under the Australian tax rules, there are various concessions or positions that can be available to protect holders of employee equity incentives from having a taxing point in connection with a change of control. However, identifying any issues early is critical to allowing Boards to design the strategy for treatment of employee equity in a way that facilitates these concessions or positions being available. Sufficient time will also need to be factored in to ensure that any clearances that are considered necessary from a governance perspective (e.g. from the Australian Taxation Office) are obtained in time so that there is no interruption to deal execution.
Clear communication with employees
When faced with a potential change of control transaction, clear communication of any in-principle decision by the Board on the intended treatment of employee equity instruments can provide substantial comfort to executives involved in the response to any control proposal and could mean that other retention arrangements are unnecessary. At the same time, making a decision too early, particularly before a Board is minded to recommend a transaction, could result in a divergence of interest and tensions with management. The timing of any decision and its link to negotiations with a bidder (or bidders) needs careful consideration.
Once a final decision is made, it is important to ensure employees are informed clearly and consistently (within the bounds of confidentiality), so they remain engaged throughout the response to any control proposal and understand the rationale of the Board’s decision.
