EMPLOYEE STOCK OPTION PLANS AS A RETENTION TOOL
EMPLOYEE STOCK OPTION PLANS AS A RETENTION TOOL ESOP’s or Employee Stock Option Plans are not a particularly new phenomenon in the corporate world. However, with the boom of start-up culture, they are in the limelight. Employee Stock Option Plans (ESOPs) refer to a plan under which the employee receives the right to exercise a certain number of shares from the company at a fixed predetermined rate. This also typically involves a waiting period of a specific duration, which the employee must wait before purchasing the stocks, which is known as the vesting period.
The history of the corporate world goes back to several centuries, but the need to reward employees by the means of Employee Stock Option Plans (ESOP’s) had been felt for the first time in 1956. A lawyer and investment banker Louise Kelso were of the opinion that the capitalist system would be stronger if all the workers and not just a few shareholders could acquire an ownership interest in the companies where they are involved. He advocated the granting of a scheme called the Employee Stock Option Plan. The concept of Employee Stock Option Plan did not originate with Louis Kelso as prior to Kelso, there were many successful companies, both public and private, that relied heavily upon employee stock ownership to increase employee motivation and productivity. Louise Kelso originated the idea of using an IRS tax-qualified plan as a tool for business succession. ESOP was adopted as an improvement tool in the U.S.A. in the 80s and 90s. The existence of ESOP has been existent in India for over a decade. This scheme is at its essence a benefit plan passed to attract and retain employees of a corporation. At the outset, the scheme was launched as an effort to benefit employees at the time of retirement in the form of a retirement plan. Over time, the scheme evolved not only to retain existing talent, but also to attract new talent in a corporation.
It is reasonable to say that the recent boost in the popularity of ESOPs attributed to the rise in the number of start-ups in the country. Generally, a start-up lacks both the manpower and the capital resources which is required to compete in the market. In order to hire and retain the best, these companies choose to supplement the salaries of their employees with ESOP’s. They execute this process by either allowing their employees to buy their shares at an extremely low rate after the vesting period is expired or by supplementing their salary with a certain share of stocks that can only be traded after the expiry of the vesting period. In this way, they do not only attract employees whom they are unable to afford but also retain them by providing incentives for profits from the shares after the vesting period.
In addition to Employee retention, ESOPs have also proven to be a powerful employee motivation tool. By linking the profits of the employees directly with that of the company, there is added incentive for the employees to contribute more towards the growth of the company. The scheme works in a manner similar to a profit-sharing system where the good of the company results in again to the employees as well. RBI GUIDELINES
ESOPs have proven to have many advantages such as increased retention of employees, because of the requirement of a vesting period, many employees choose to retain their position at a company and in case of severance of employee before the end of the vesting period, and the employee would not be able to exercise their option of buying stocks. It also helps companies hire at lesser costs and decreases the day-to-day costs of functioning. The company can offer ESOPs in lieu of a part of the salary, furthermore, by assigning these shares to persons within the company, the company also provides its employees with a sense of ownership of the company, which motivates them to work harder. To exhibit the advantages of ESOP, the example of Infosys is to be understood. In its early days, Infosys offered ESOP’s to almost all its employees, ranging from executives to clerical staff, and those who chose to retain it have now become millionaires due to the same.
However, there are also certain clear disadvantages to the scheme of offering ESOPs. If seen from an employee’s point of view, the disadvantages of ESOPs as a retention tool could be many. Firstly, the issue is related to its diversification and control. The board of the ESOP controls the shares and speaks for the participating employees. Additionally, if a company performs poorly and an employee has the majority of his or her retirement savings in the ESOP, then the value of the employee’s retirement account is negatively affected. Often, there are several stipulations attached to the issuance of these options. While an employee holds shares, they are not considered as shareholders in the company and hence they have no say in the functioning of the company. Further, people joining in the early stages of the company tend to get a higher level of ESOP, which offers a higher multiple of wealth creation as an acknowledgement of their risk and their efforts to bring up the organization from ground level. As the years pass by, the numbers come down and so the multiple, since the issue price goes up as the organization grows. If the number becomes too low, it becomes tougher to deliver some of the benefits commonly associated with ESOPs.
Therefore, we understand that while established companies use this option as a retention tool, startups use it to hire talent. Hence, this concept of Employee Stock Option Plan has emerged as the most attractive idea to enhance the performance of employees and expedite the growth of the business as well.