APPENDIX FOUR Operation of the management incentive scheme

The share incentive scheme had four elements that provided different levels of returns:

1  All employees received forty share options (for free) that were exercisable from the flotation onwards.

2  All employees could choose to invest a minimum of £500 in the co-investment scheme. This scheme was structured on the same basis as the shares held by the Department and Carlyle that consisted of non-voting redeemable preference shares and ordinary equity in a ratio of 9:1. Essentially, for every £500 investment, £450 was invested as preference shares and £50 as ordinary equity. The preference shares paid interest at 9 per cent that was compounded annually and payable when the preference shares were redeemed. 

3  The top 245 senior managers were given the opportunity to invest in ordinary equity that benefited from a performance ratchet. 

4  The top 10 managers were given the opportunity to invest in ordinary equity that benefited from a double performance ratchet. 

The top 245 and top 10 managers could be requested to sell their holdings of ordinary equity before a flotation for the lower of the purchase price or the fair market value, as determined by the Board, if they were considered to be a 'bad leaver'. The Board had some discretion in the determination of what constituted a 'bad leaver' but this could cover voluntary departures and dismissals. 

The returns available to these different classes were related to the eventual value of the company but the ratchets would award more shares to the top managers when certain performance thresholds were met.

The First Ratchet: This represented an additional allocation of 5.05 per cent of ordinary shares to the top ten (2.75 per cent) and the top 245 (2.30 per cent) senior managers if the value of Carlyle's and the Department's investment increased at flotation by more than three times and achieved an internal rate of return of 30 per cent.

The Second Ratchet: An additional 2.53 per cent of ordinary equity was allocated to the top ten senior managers if the value of Carlyle's and the Department's investment increased at flotation by more than four times and achieved an internal rate of return of 40 per cent. 

Effectively, the ratchets diluted the shares held by the Department, Carlyle and the co-investment scheme proportionally to the size of the shareholdings after the operation of each ratchet. The operation of the ratchets awarded senior management an additional 7.3 per cent of equity, 4.8 per cent coming from the Department and 2.5 per cent from Carlyle. The overall effect on the percentage of shareholdings per class of investor is demonstrated in Figure 20.