Surveys

ESOP Direct

Survey on Underwater Options

Participants' profile

The list of participants is impressive from several angles.
   
It includes companies such as Infosys, Wipro who have not only been the first ones to issue stock options to employees, but have also been trend setters in terms of coverage, communications and adherence to best practices.
   
Number of ESOP holder employees for all the participating companies exceeds 30,000.This forms a significant proportion of total ESOP coverage in India.
   
Around 80% of the respondents are listed companies. The impact of underwater options is more tangible in this sector because the market value is readily available. This has contributed immensely in making the findings of this survey more representative and relevant.

Fairly significant share of 27% of Non IT companies has also helped in covering the sectoral views on this subject.

How common is this phenomena?

The findings here are in line with the general perception that most of the companies are grappling with Underwater Options.

We would however like to point out that even though 73% of the companies have Underwater Options, the percentage of options that are Underwater would be lesser. In case of many companies,who have made several grants, some grants are Underwater whereas others are In-the-money.

It would need further analysis and information to comment on the percentage of options that are Underwater.

The figure of 73% is however very relevant to understand that 3 out of every 4 companies have this issue on hand and will have to address it sometime.

Perceived reason

Overwhelming majority of companies feel that the temporary downturn in the market is the sole reason for options losing their charm.

In essence the message is that cyclical upswing in the market will automatically take care of this loss in value and no action need to be taken. This view is confirmed when 73% of the companies say that they have not considered re-pricing.

We firmly believe in this rationale. However, what needs to be seen (on a case to case basis) is what is the extent of loss in value. There is a popular belief that many companies will not see the same valuations as in the recent past. In which case the reduction in value is permanent and needs corrective action.

This indeed is a call every company has to take based on individual circumstances. There is no generalised solution.

Employee Communication

Effective communication to employees has been a neglected aspect in the overall ESOP implementation process in India.

In our opinion, one of the major reasons for ESOPs losing their sheen today is that it was marketed/communicated improperly in the first place. Expectations of employees were raised to very high levels. They were not educated about the associated risks and downside of this instrument.

The survey findings strongly support our views. More than 2/3rd of the companies did not educate the employees about the associated risks and downside of the plan.

We believe that in the coming days, effective and timely communication and creating awareness about this instrument is going to play a very crucial role in the ESOP implementation process. Employees need to told about Why are the options Underwater? What is the company doing about it? Why is the company not revising the terms? What should employees do to mitigate the loss,etc.

Implications of Re-pricing

Are companies aware about the various implications of the Re-pricing decision would have? If they are aware, then what will drive their decision to re-price?

We find the overall awareness about the implications is not very high. Most of the companies (80%) are aware about the impact on the share holders, but a significant number (33%) is not aware about the accounting implications. More than 50% of the companies are not aware about the alternative methods for addressing this issue.

More than 67% of the companies do not know the US GAAP related impact of re-pricing.

Benefit to employees seem to be driving the decision to re-price for most of the companies (80%). The impact on shareholders,accounting hit, impact on equity, etc. are perceived to be issues of lesser importance. This response is probably because of lack of awareness and our findings corroborate this opinion.

Alternative approaches to Re-pricing

In the US where underwater options is not a new phenomena companies have tried several ways to retain the value of options and maintain employee interest in them.

We tried to find out whether some of these approaches appeal to the Indian companies.

On the whole it appears that they are relatively less inclined to try out new methods.

One of the reasons, we feel is because there is resistance to change whatever has been laid down. In India, we are yet to see companies having several plans, different structures etc. The approach is to fit in every employee in the same structure. Hence we see outright rejection of 'selective re-pricing". If the senior team was responsible for lack of performance, why not penalise them more than the junior team. Why not differentiate?

There is a need to create awareness about the methods such as frequent grants, shorter terms and exercise periods etc. These in isolation or in a combination, can be effectively used to pre-empt the widespread occurrence of Underwater options.

Time frame for action

More than 50% of the companies want to address the issue but an equal proportion have not yet decided when they want to take it up.

Perhaps they want to wait for the upswing in the sentiments or they want to link it to the time when the compensation structure is reviewed.

Conclusion

About six months ago, we came out with India's first survey ESOP Design Practices 2001 addressing the information need on how companies are designing their plans. This time we took up another major contemporary issue of Underwater Options. We have tried to make companies think on this issue and in the process create awareness on this subject about which very little is known to the Indian corporates.

We believe we have achieved our limited objective. As we proceed further, such critical issues will be discussed more openly and candidly thereby leading to more information and knowledge sharing. We would have then achieved our larger objective.

In the meanwhile look forward to more such informative and analytical studies.

In case you need access to the complete Survey report please write to consulting@esopdirect.com

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