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ESOP catching up in India

Aru Srivastava

Some years ago when India was into its reform era and the economy was upbeat, the markets were prosperous, thanks to the consumer durable boom. The buzzword then in the employment industry was switching jobs.

Everyone (especially in the finance sector) wanted to be associated with a foreign (sounding) name and job switches were happening faster than channel zapping. Each jump meant a bigger pay packet, a bigger car, and better perks to keep these nimble-footed managers in a happy and stable state of mind and job.

Switching jobs happens in all industries, it happens all the time whether the economy is doing well or it is not. However, the impact of these switches is more pronounced in certain industries than in others. In industries where your main edge is your intellectual assets it becomes even more important to keep this pool of brain power growing -- and with yourself.

Then also comes the question of acknowledging the efforts of the top performers and rewarding them. Just salary and perk raises don't suffice, these are rewards which are easily eaten away by inflation and what looks so good on paper doesn't really translate into what you expected. So how does a company keep and reward its star performers?

The only way of ensuring a person's commitment to your dreams is by making them a part of his dreams and that can happen only if you can give him a piece of that dream, a feeling of ownership over that dream, make him an owner of that dream. So taking a leaf from the Western gurus the Indian employers also turned savvy and introduced Employee Ownership Programmes.

These plans can be applicable for listed as well as unlisted companies. Research in the US shows that when employee ownership is combined with a management style that encourages employees to share ideas and information, companies grow 6 % to 11 % per year faster than would be expected otherwise.

'Theory O', the ownership style of management, fosters growth. An employee ownership programme is just what the name suggests, a programme which entitles the employee to own a piece of the company. These plans/ schemes are normally designed for:

* Establishing pay for performance
* Wealth creation for high performers
* Talent retention

An Employee Stock Option is a kind of qualified employee benefit plan, meaning it qualifies for tax benefits if you abide by certain rules. A company sets up a trust fund for employees. The company then contributes cash to the trust so that is can buy company shares or just contributes shares. Alternatively, the trust can borrow money to buy shares, with the company repaying the loan by making contributions to the trust.

Once shares are in the trust, they are allocated to the accounts of at least all full-time employees (with some limited exceptions). They are then subject to vesting, and employees receive their shares when they leave the company. At that point, they can sell them back to the company or in the market, if there is one.

Closely held companies must have their share price set by an annual outside appraisal. Employees own the shares through the trust, but closely held companies can control the voting of the trust on almost all issues if they so choose.

In the US the ESOP is the most tax-advantaged mechanism for companies to share ownership with employees. In India, however, it is treated as a perquisite and is subject to tax at two points.

One, when the company issues the stock option, then the differential between the market price and the price at which the stock is offered to the employee under the ESOP would be taxed as a perquisite. Also when the employee sells his stocks. Then he has to pay capital gains tax on the differential between the cost of acquisition and the sale price. The draft guidelines on ESOP and ESOS issued by the Securities Exchange Board of India clearly give the rules and definitions applicable to the same.

The Employee Ownership Plans use a host of plans through which they deliver the goodies. It could be a stock option scheme -- which is the most commonly used. A stock option gives an employee the right to purchase a set amount of shares at a fixed price for some years into the future. It could be a stock purchase or a restricted stock. Some types of plans involve actual purchase and holding of stock or a phantom stock, or could be a cashless exercise.

A phantom stock is a bonus that rewards employees based on the increase in the value of the company's stock, the dividend performance of the stock, or both. Stock Appreciation Rights are similar, and in effect consist of phantom stock without phantom dividends. Some MNCs offer global stock options for stock listed outside India. The vesting period, that is, the period for which the option has to be held, differs from 2 to 5 years depending upon the industry, company, management policy, etc.

A company could have more than one stock option plan.

"We were awaiting the clarification of rules regarding the stock option scheme, but in the meanwhile we had already introduced a modified form of the same,'' says Sanjiv Kataria of NIIT, a leading software and computer education company in India. ''Other than the usual employee quota issued at the time of the initial public offering, the directors themselves gave shares to the employees out of their quota, and, believe me, most of our employees are still with us today. So you could say that we have actually met our objective of introducing the scheme. We are now finalising the details of a plan as per the guidelines announced in the Budget."

Eli Lily Ranbaxy is an example of a pharma major which extends its overseas ESOP to its Indian employees.

Infosys, a leading Indian software major, has been credited as having created a large number of Indian millionaires. The employees who received the stock of the company have benefited manifold by the spectacular rise in the share price.

These are but a few examples of the companies which have tried and succeeded with this concept in India.

A recent study by Noble & Hewitt which studied a sample of 94 Indian companies revealed that 29 (31%) companies had Employee Ownership Plans.

Of the industries studied, pharmaceuticals, infotech, banks and financial services were the toppers in introducing these programmes. Employee Ownership Programmes are also popular among MNCs which typically extend their global stock options to their Indian employees.

The infotech, financial services and pharmaceutical industries have also awakened to the benefits of the Employee Ownership Programmes.

So the Budget for 1999-2000 which has clarified a number of issues on the subject will herald a new dawn in the employee benefit programmes.

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