4.18 Although not specified as an objective at the outset of the privatisation, the Department had given assurances to the House of Commons Defence Committee that it did not want to see individuals becoming instantly rich simply by virtue of the privatisation, although it considered that if the management prospered because the business had, this would be acceptable. The Department considers that the eventual returns received by management were consistent with the objective of maximising the growth in the value of the business.
4.19 The success of the flotation ensured that the second performance ratchet in the management incentive scheme, which was based on the increase in equity value, was surpassed. The highly geared structure of QinetiQ at the time of the sale resulted in a relatively low initial equity value, which was the baseline for measuring the increase in equity value. Appendix 4 sets out how the ratchets (see paragraph 2.19) substantially increased the shareholdings of senior management. The value of the shares held by the various classes of shareholder and the top four managers under the scheme are set out in Figure 19.
19 | The returns to senior management at the date of the flotation | ||||
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Shareholder | Total investment (£ million) | Value of shares at flotation (£ million) | Return on Investment (%) | Return for each £1 invested | |
Top 10 | 0.54 | 107.45 | 19,900 | 200 | |
Top 245 | 0.45 | 65.26 | 14,400 | 145 | |
Co-investment scheme | 4.63 | 41.04 | 786 | 9 | |
The Department | 78.12 | 689.92 | 786 | 9 | |
Carlyle | 42.25 | 374.22 | 786 | 9 | |
Share options | Free | 24.67 | N/A | N/A | |
Chief Executive(Sir John Chisholm | 0.13 | 25.97 | 19,900 | 200 | |
Chief Financial Officer(Mr Graham Love) | 0.11 | 21.35 | 19,900 | 200 | |
Group Commercial Director(Mr Hal Kruth) | 0.07 | 13.88 | 19,900 | 200 | |
Marketing Director(Ms Brenda Jones) | 0.06 | 11.18 | 19,900 | 200 | |
Non-executive Directors | 0.10 | 0.89 | 786 | 9 | |
Source: Wilmington Capital report commissioned by the National Audit Office, July 2006 | |||||
4.20 In June 2005 the Department negotiated 'lock up' arrangements, the provision for which had been set out in the Shareholder Subscription Agreement at the time of the sale to Carlyle. These restricted the ability of the top ten managers to sell more than 15 per cent of their shares at the flotation and set limits on what they could sell for the following three years. This ensures that management continue to be incentivised to grow the value of the business. Although some of the top ten managers sold shares at the flotation, the chairman (formerly chief executive officer) and chief executive officer (formerly chief financial officer) did not.44 The lock up arrangement for the chairman, however, allows him to sell all his shares from August 2007 if he relinquishes his non-executive role in the business.
4.21 The share incentive scheme encompassed more staff than most private equity transactions and the total proportion of equity available to staff was towards the high end of market practice, as were the returns to the top four individuals. The Department considers that the incentive scheme was an integral part of the achieving the growth realised at the flotation and that the targets set were challenging given the assessments of likely growth made at the time. We believe that a comparable increase in the value of the business could have been achieved with the prospect of more moderate returns for management. The Department and QinetiQ disagree with this conclusion and believe a different incentive structure could have restricted growth at the top end and reduced the overall return to the taxpayer. Although we accept that limiting returns to management can diminish the attraction of such deals to potential investors, we consider that the returns in this case exceeded those necessary to incentivise management to deliver the growth achieved in the value of the business.
4.22 The Department allowed Carlyle to design the structure of the incentive scheme with input from QintetiQ management, believing that its interests were aligned with Carlyle's who had experience of designing incentive schemes. It did not seek separate professional advice from specialist consultants, or the remuneration committee, on the structure of the incentive scheme. The Department considers it would not have been appropriate to rely on the views of the remuneration committee in approving the incentive scheme. It believes the review of a limited range of potential outcomes based on the expectations of growth at the time (see paragraph 2.17) gave it appropriate assurance that its interests were protected. The remuneration committee, however, did consider it had an interest in the scale of returns management could receive and commissioned Rothschild to conduct analysis of the potential extent of the returns (see paragraph 2.17).
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44 The current chief executive officer, Graham Love, sold 2.9 million shares, approximately one third of his shares in the business, in February 2007 but purchased an additional 50,000 shares in August 2007.