BHUMAN CAPITAL Vol.6 No.1 June 2002
Harshu Ghate, Managing Director, ESOP Direct ( harshu@esopdirect.com)

ESOP Direct is India's leading ESOP administration and consulting company

There are more than 300 Indian companies who have implemented ESOPs. Quite a few of them have Plans that are running for more than two years, though a much larger number of Plans have a shorter history. In the overall ESOP process, designing a Plan and granting Options to employees was seen to be the most important process milestone. Very little attention and effort is allocated to efficient administration and management of a Plan. For instance very few companies take efforts to find out whether employees have understood the Plan, are their queries and anxieties properly addressed, are they made aware about possible gains and risks? From the management's perspective the effort involved in compiling basic reports on ESOPs are much higher than required. Most of the companies do not have suitably automated solutions to manage data and records. If companies have structured data available on past grants, allocations, % of vested options exercised, etc it would facilitate their decision making. Added to this is the recent regulatory framework that requires companies to file periodic information with Tax authorities to gain tax advantages. It will not be unfair to say that ESOP administration has been a neglected function and in most of the cases it is restricted to issuing grant letters and processing exercise applications. ESOP administration has much more to it.

What does ESOP administration involve?


Grant of options: There are several sub activities here such as preparation of list, approvals of Board/Compensation committee, executing Grant agreements, accounting entries, etc.
ii) Vesting of options: Mostly vesting is a function of time and very few Plans provide for performance-based vesting. Depending on the Plan, options have graded vesting with a certain portion getting vested at pre defined time intervals. The activity involved here is of communicating with employees about the vesting event.
iii) Exercise of options: This step has several sub activities such as receiving exercise application from employees, processing it, receiving payment, issue of shares, listing of shares, etc. For every issue of shares is followed by a listing process in which several external agencies such as Share registrars, Depository participant, NSDL, Stock exchanges, etc are involved.
iv) Lapse: All plans provide for Exercise period within which the vested options have to be exercised. The Options lapse beyond this period. It is very important here to notify and caution the employee about the likely lapse. Each lapse also triggers an accounting entry for reversal of earlier entry.
v) Separation: Most of the plans provide for treatment to be given to vested and unvested options when the employees leave the organization. The treatment is dependent on the reason for separation like death, retirement, resignation, termination, transfer, etc. Many plans also provide for a different exercise periods depending on the reason for separation. Such periods need to be tracked. Adequate steps to cancel the unexercised options need to be taken.
vi) On-going activities: During all these activities there are Management reports to be generated, data required to be. Audited and disclosed in the Annual accounts and submissions to Tax authorities to be made. Communication to employees, their training and redressal of their queries is also an on-going process. This is a very critical activity and plays a crucial role in making or breaking the effectiveness of the Plan. With the introduction of guidelines for Prohibition of Insider Trading, companies now have added responsibility of tracking and regulating the shares held by the employees.

Players involved

The entire ESOP process involves several internal departments and external agencies. Normally the internal functions involved are the employee, HR, Finance, Secretarial and legal. The external agencies involved are Share Registrars, Stock exchange, DPs, Bankers, Auditors and Administrators.

Internal and external processes

There are some processes such as grants, employee communications, vesting, lapse, etc to be managed internally whereas some processes like issue of shares, listing, submissions to tax authorities, disclosures, etc require interaction with external agencies.

Repetitive processes

There are several processes that are repetitive making the entire activity ideal for automation and outsourcing. Apart from the grant decision, which involves deciding the quantum of options and where senior management's inputs are critical, all the other processes can be streamlined and defined in a process manual that can be implemented by any professional agency. The company management needs to supervise and wherever necessary approve/ authorize certain actions.

Why outsource?

Apart from well known reasons why companies outsource the non core processes, such as cost effectiveness, concentration on core processes, etc. a major driver in case of the ESOP Administration process is lack of in house domain knowledge on the subject. In terms of knowledge of regulations, their applicability and interpretations and also in terms of prevailing practices and trends, there is very little awareness amongst the corporate executives about this subject. This justifies handing over the process to professionals who are aware about the issues involved, the prevailing laws and the best practices in the field.

With ESOPs being adopted by wider spectrum of companies, more regulations being enforced, global plans and overseas employees being covered, ESOP is fast becoming a subject requiring specialized knowledge and expertise.

Globally ESOP administration is a highly specialized professional service with dedicated service providers.

Issues in outsourcing

Like any business process outsourcing decision, there are several issues that need to be addressed while evaluating outsourcing of ESOP administration. Let us look at some of the critical issues that any management will face.

Confidentiality of data:

It is a common perception, and to a large extent justified, that ESOP data is a very confidential piece of information and parting with it or hosting it on an external server/computer will be risky. It is true that since the ESOP data relates to employees and their earnings, it is confidential and companies may not want to share this information with an outside agency. However the same logic can also be applied to the Payroll data, which also is very sensitive employee information. Payroll outsourcing is a very common practice even in India. Same is the case with accounting information. Many companies outsource their Accounting function to professional firms, equally large number outsource the CFO function. These agencies also hold very sensitive financial and business information about their client companies. They have gained the confidence of the companies who have no discomfort is sharing information with them. The same comfort can be developed and gained by ESOP service providers.

Will it be cost effective? What is the saving potential?

At the outset this is dependent on a host of factors. Size of the company, number of employees covered, whether the company is listed (whether employees can sell their shares), number of locations of employees, frequency and quantum of options granted, the way the process is managed internally, etc are some of the factors that will determine the potential for saving. If the management were keen on streamlining the process and making it more responsive to the employee needs, outsourcing the administration process to a professional agency would certainly be cheaper than doing it in-house.

What are the Service levels I can expect from an external ESOP Administrator?

As a user of a professional service, a company should expect performance assurances on issues such as response time to queries, timely and accurate reporting, uptime of the application and servers hosting the data, security and confidentiality of data, time taken for updating and processing of data, etc. The service levels would also depend on the extent of outsourcing. For instance if the process for listing of shares is also outsourced, service levels for timely completion of this process would also be included. In case the service provider is also responsible for giving advise to employees on their taxation of ESOP benefits then service levels relating to such advise would also be included.

How should I go about deciding the service provider?

Firstly it is important to decide what is the extent to which the process will be outsourced. Here laying down the complete process flow and then deciding the functions to be outsourced will help in crystallizing the roles and responsibilities. Clarity in role definition will also help in drafting a good service contract and in defining the service levels.

Choice of the technology to be used by the service provider is also a crucial decision. Broadly the choice here is between a web based on line service vis a vis use of an off line desktop application. It is also important to decide whether you want the service to be delivered in your premises (on site) or at the service provider's premises (off site).

Along with these specific issues other usual evaluation criteria like references, client list, track record, stability, profile of the team handling the process, internal processes and quality checks practiced by him, etc should also influence the decision about the service provider.

Global practices

Administration of Employees Stock Plans is a very well established service in the western countries especially in the US. More than 75% of the reasonably sized companies outsource this function to a specialized service provider.

In terms of the choice of technology, larger number prefer the off line model, though a significant number and especially bigger listed companies prefer web based service giving access to employees world wide to their ESOP data.

Most of the companies prefer outsourcing the complete process. The service contracts are well structured to take care of service levels and other commitments.

Most of the service providers also handle the trade transactions of employees by proving an on line share trading service. Few of them also provide on line Banking service and advice on investments. Some of the well-known service providers in this filed are E * Trade, Salomon Smith Barney, Paine Webber, Equiserve, etc.

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