The sooner a company grants
Esops, the better for its shareholders and employees.
The current meltdown in the stock
markets has had a devastating impact on the value of stock options
companies have issued to their employees. Most of the options issued
at market prices 12 to 15 months ago are underwater. Needless to
say, there is no excitement among either the option holders or the
issuers regarding these.
However, given the enormous
success employee stock option plans (Esops) have met with in the
last three to five years, this time no one is writing them off as a
useful tool in fostering motivation, retention and attraction of
Contrary to popular belief, the
most appropriate time to grant Esops is when the markets have hit
the bottom. The option holders get shares at the lowest possible
price, with no downside risk and higher potential upside. The
shareholders can do with lower dilution, since you will need fewer
shares to give the same amount of benefit.
Table shows how companies will
have to issue 20% more shares if they delay the grants by a year and
73% more shares if one delays the grant by two years.
However, not many companies seem
to view the current downturn as an opportunity. Employees also seem
to give preference to cash incentives over Esops.
Among the top reasons for this
lack of interest among the companies is their belief that the
current meltdown is not restricted to the stock market and rather
reflects an all-pervasive recession which is expected to run well
into 2010. Given this timeframe, they are not sure if share prices
would appreciate significantly enough to make a difference to the
value of Esops in the coming 18-24 months.
The fact, however, is this itself
is an opportunity. Esops by their very nature are a medium to long
term instrument. The legal stipulation is for a minimum one year
vesting, but typically, the vesting spreads over 3-4 years. A
company with a sound business model is bound to bounce back in terms
of performance and market pricing in the next 2-3 years. All global
analysts are unanimous that countries like India will be faster off
the ground in overcoming the recessionary impact than the US and
As the table shows, the earlier
the companies grant Esops, the better it is for the shareholders and
for the employees.
Some promoters are of the opinion
that the current valuation is not a true reflection of the companyís
inherent value and issuing options at that value would mean
acceptance of the valuation. The point is well taken. Many companies
are quoting at less than book value, which certainly is not a
correct reflection. However, it is possible to structure options
wherein the exercise price is decided on the date of vesting with a
look back/ look forward feature. This will give adequate time for
the true valuation to show up in the market prices.
Many unlisted companies would want
to link their Esop rollouts to the IPO plans. This will ensure
certainty of liquidity for the employees and eliminate cash payouts
by the company. In the current situation, all IPO plans and hence
ESOP rollouts are deferred.
It is possible in such cases to
link the exercise to the IPO. Here, the options will vest but are
exercisable on IPO. The employees need to be educated adequately
about these terms. They would not mind this since they are not
required to invest till the IPO materialises. The exercise period
could be kept appropriately longer.
The other reason commonly heard is
that in the current situation, retention is less of a challenge.
There are fewer jobs in the market to lure them and those available
will not offer aggressive salaries. While it can be argued that
retention at junior levels of management could be less of a
challenge in the next couple of years, the same is not true for the
managerial staff. Management skills are still in short supply and
these resources could seek greener pastures even in the current
scenario. Esops are essentially meant for the managerial staff and
not for junior staff, who usually prefer cash incentives. In fact,
if the company has in the past spread the options thin with a large
number of employees, this is an ideal opportunity to amend the
allocation and to focus only on those who would be critical to tide
over the current recessionary phase.
Lack of employee interest is also
cited as a reason for companies to defer their Esop initiatives.
Employee awareness about Esops has been quite low the world over.
Just as the small investor flocks to the market to buy in the
booming market and sells desperately in the slump, employees also
believe that Esops make sense when the prices are already high and
rising fast. Firstly, the employees need to be educated that Esops
are not shares where you book profits or losses on a daily basis. It
would be worth the effort to create this awareness among the
employees in order to align their goals with those of the promoters.
To be fair to the employees, their
dejection is understandable. No one would want to have an option
which has potential to go underwater. It is possible to structure an
option which will ensure that they are always in the money at the
time of vesting.
Quite a few companies, which have
granted options earlier, are under water. If for some reason they
find that re-pricing is not the solution, they could use the timing
to grant options at a lower price so that the employees can average
out their cost and still be in-the-money at an aggregate level.
Any option design will have to
work within the four corners of dilution, benefit, employee coverage
and accounting charge. It is possible that if you give more weight
to one parameter, the other will get impacted. While itís important
to prioritise the parameters, it is necessary and possible to
optimise them to achieve buy-in of all the stakeholders.
Indian Inc has always responded
commendably to all the business challenges, be it globalisation,
rupee valuation or the current meltdown. Here is an opportunity to
handle the situation equally ingeniously to ensure they maintain the
edge with a motivated workforce.