the recent past a lot has been written about how ESOPs is all hype
and no substance. Corporate managements have been blamed for taking
the employees for a ride by creating unrealistic expectations about
the value of the options they hold. Press reports highlighting how
the options are not even worth the paper they are written on are
regularly seen. So is it all over for employers and employees as
far as their ESOPs are concerned? Should companies discard their
ESOPs and look out for some new incentive mechanism? Will ESOPs
never work in the Indian environment? Will the fate of ESOPs swing
with the ups and downs in the Software industry? There are several
questions being raised. There is a need to look at this instrument
in a proper perspective.
It is beyond doubt that during the boom period in the Software sector,
ESOPs were projected as a simple and sure way of making money. Companies,
under the compulsion of attracting and retaining good people, created
unrealistic expectations of employees about the company and ESOP
valuations. The Press also went head over heels in highlighting
how a driver in Infosys has become a millionaire, thanks to the
ESOP he holds. There was indeed a lot of hype created. All this
euphoria died down the moment stock markets collapsed and so did
the ESOP values. Employees, who were never made aware about the
possible downside of holding Options, started blaming the companies
for the losses. Suddenly, ESOPs became a no no.
ESOP is a reasonably new phenomenon in India, not more than 5-7
years old. In all these years the only way the stock markets have
moved is upwards. So the companies and employees have only seen
the profits one makes (could make) from ESOPs. Its like, no small
investor is grudging during the booming markets. He suddenly starts
seeking protection when the markets crash and he is found at the
wrong end of the market. Just as it took some time, almost a decade,
for several new financial instruments to stabilize, we should give
enough time for ESOPs to stabilize.
new instrument or an idea goes through these phases during its
life cycle. First you have an "expectations" phase
where very high expectations are created about the utility of
the instrument. References and case studies of success stories
are quoted in abundance. Everyone rides this phase, be it corporate
managements, employees or consultants. Then you have a "disenchantment"
phase. The overdose of expectations soon settles down and starts
confronting with reality. Employees find that projected share
prices are unlikely to be achieved and that they have been misguided.
feel that ESOPs are not fulfilling their stated objective of retention
and attraction of talent because employees no longer care whether
you give them options or not. Lastly you have the "stability"
phase. Here both the managements as well as employees have reasonable
expectations about the instrument they hold. They are aware that
what they hold is not a magical wind that can only make them millionaires,
it also has limitations and downside. Corporate managements do not
create wrong impressions about the value the shareholders are sharing
/distributing to employees.
This life cycle is true for any new initiative, be it a new business
concept, a new financial instrument, a new technology or a new career
opportunity. We have seen it happen to Mutual funds. Many have not
forgotten the amazing response the Public offerings of Morgan Stanley
received when they launched their first fund in India. Expectations
of investors were raised to crazy heights. Mutual fund units were
sold as if they were Shares. It was obvious that these units once
listed would not be quoted as high because their price was a function
of the NAV. Once the NAV and price went below par, all these Funds
were booed and hated. The disenchantment set in. It is only recently
that Mutual funds have gained their due respect. Now no one expects
units to appreciate in the short run as much as some of shares.
They have now stabilized. Not long ago Internet technology went
through this cycle. Till 2000 it was going through the "Expectations"
phase. Anything related to internet or with an "e" in
the name was latched up. For the last year and half it is going
through a "Disenchantment" phase. Some of the genuine
internet and dotcom companies hated to call themselves one. Very
soon it will enter the "Stability" phase. ESOP is not
and cannot be an exception to this theory.
One more reason why I believe that ESOPs will pass their current
test for survival in India, is the experience of the developed countries
with this instrument. Every country is going through a slump in
stock markets and Options of thousands of US companies are under-
water (have a negative value). In spite of this no one is talking
whether they should continue giving Options. On the contrary companies
are re-pricing their options downwards and issuing more options
to compensate for the loss. Several State governments including
those of US, UK and Australia have specific laws for ESOPs, many
have tax concessions if the Plans are broad based, they allow and
in fact encourage Stock Purchase Plans where employees contribute
on a monthly basis towards purchase of company's stock (similar
to a Provident Fund ). In the US there are more number of unlisted
companies than listed ones who have given stock options to their
employees. Similarly every reasonably sized company ( whether in
the Software sector or not) has a Stock Option plan in place. As
per a recent survey around 25,000 US companies have granted Options
to more than 10 million employees. Clearly ESOPs in these countries
are going through the "Stability" phase. No hype no undue
So what's the fate of ESOPs in India? There is every reason to believe
that the current disenchantment with the Stock Options would soon
be replaced with a much more matured and down to earth understanding
of this instrument. Managements with their experience will tone
down their sales pitch. Employees will realize that ESOPs may also
have a downside. They have to understand that once they own the
company's stock they have to factor in the market risk. Stock Option
is not a fixed income savings instrument, where there worth will
only grow. The value would fluctuate with the swings in the stock
markets. The best way for them to optimize their gains is through
a same day sale or cash less transaction, where they do not invest
any money at all and only pocket the difference. In other words
they can prolong the exercise till the market prices become attractive.
There is a need to educate employees about these associated issues.
Worldwide companies assign very high weight to the employee communication
in the overall ESOP process. On-going sessions are held with the
employees explaining them how ESOPs work. Managements need to do
a lot in terms of managing the expectations of employees.
Stock options have been widely used world over for more than two
decades. There are several studies that show that companies with
Stock Option Plans have performed consistently better than those
who do not have one. Over a longer period employees have gained
significantly from their Options. The concept has received encouragement
from Governments as well. Counties like UK are also thinking about
introducing this concept in Public sector and Government owned enterprises.
Let us give some more time, around 15 to 18 months at best, for
ESOPs to enter the "Stability" phase and then one should
see a smooth stable ride both for the employees and managements.