ESOPs: IS THE PARTY OVER ?
Harshu Ghate, Managing Director, ESOP Direct

HUMAN CAPITAL VOLUME 5 No.7 DECEMBER 2001
 

In 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.

Every 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.

Managements 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 expectations.

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.


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