Employee Stock Option Plans

Employee stock options plans are adopted by many companies to compensate, retain, and attract employees. Under these plans the employees of the company are given the right to buy a specific number of the company’s shares at a fixed price within a certain period of time. Employees who are granted stock options hope to profit by exercising their options at a higher price than when they were granted.

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Since the late 1980s, the number of people holding stock options has increased manifolds as these options are one of the methods used by companies to reward top management and "key" employees.

Under the popular stock option plans, the company saves on cash outflows by issuing ESOPs. If the stock markets are on the rise the employees will be more open to accepting ESOPs in lieu of cash. The company this way will attract talent and the employees will feel motivated to go the extra mile as shareholders. ESOPs have also worked as retention tools since shares generally get vested after three years.

Apart from giving financial gains to the employees, ESOP also creates a sense of belonging and ownership.

But the current market meltdown has led to a situation where the employee stock option plans will provide no real benefit to employees. As a result here is a strong possibility that employees will now start spurning stock option offers, preferring instead to be compensated in cash.

All about Employee Stock Option Plans

There are two ways in which a company can set up an ESOP.

Trust (Special Purpose Vehicle)

The company will issue shares or options to the trust, depending on the number of options to be given to the employees The funds needed by the trust to buy these shares would be given by the company either as soft loans, or from its own funds. The trust can also raise loans through other sources with the company providing guarantee to the lender. The trust then acquires shares/options required with the funds raised. The trust repays its loans as and when the employees purchase the options offered and when they exercise their options by paying the exercise price.

Direct option to employees

The employees can be selected according to their performance, indicated by the annual performance appraisal, minimum period of service, their present and potential contribution and other factors considered relevant for the success of the company. Based on the objective of the company the number of options per employee can be determined by taking into consideration, the grade, level, years of service, salary, etc.

Different types of ESOPs

Major ESOPs are:

• Employee Stock Option Schemes
• Employee Stock Purchase Plans
• Compensation Plans
• Incentive Plans
• SAR/Phantom ESOPs

Employee Stock Option Scheme (ESOS)

Under this scheme, the employees are given an option to acquire shares at a future date at a pre-determined price. Eligible employees can acquire shares on vesting within the exercise period and are free to dispose of the shares subject to lock-in-period if any.

Employee Stock Purchase Plan (ESPP)

Applicable mostly in listed companies, under this scheme the employees have the right to acquire shares of the company immediately and not at a future date as in ESOS, at a price lower than the prevailing market price. The employees cannot sell the shares issued by the listed companies under ESPP as they are subject to a lock-in-period. The employee also has to continue with the employer for a certain number of years.

Share Appreciation Rights (SAR)/ Phantom Shares

Under this scheme, no shares are offered but the employee is given the appreciation in the value of shares between two specified dates as an incentive or performance bonus, that is linked to the performance of the company as a whole, as reflected in its share value.

90 degrees

In a global research study conducted by the Hay Group on the impact of the economic uncertainty on reward programs released in December 2008, it emerges that nearly 40% of the companies surveyed worldwide did not have an equity grants program. The companies are also reported to be reviewing their long-term incentive programs.

However, 12% of the companies worldwide indicated that they are making or considering changes, but were uncertain about what actions to take. According to the study, 50% are considering granting fewer options/shares/units; 42% are considering granting more; 53% are considering changing the mix and 32% are considering reducing the performance criteria for vesting.

References:

• Employee Stock Options Fact Sheet
• Rewards, not Esops, can motivate
• ESOPs - Employees Know you Kitty
• Employee stock lolly turns bitter