How does one measure whether ESOPs are working?
ESOP is a tool for creating ownership and wealth creation for employees. ESOP envisages a right given to the employees of a Company to get shares at a predefined price and over a predefined period. Primary objectives of ESOP’s implementation are to ensure long term commitment of employees, participation in growth and wealth creation for employees. Setting the objectives being a prerequisite is just a beginning. Another prerequisite is to evaluate whether ESOPs post implementation have been instrumental in achievement of underlying objectives.
Now, the question is how to measure if ESOPs are working in line as desired. Below are few key tests for such measurement:
- Employee Satisfaction – Company can have annual/ half-yearly surveys, where employees can be asked questions to get a sense of degree of their understanding of the ESOP plan terms, their feedback on ESOP plan, and whether they are confident in reaching the long-term financial/ other goals. These surveys need to be structured properly so that the feedbacks can be used for future ESOP grants with suitable terms, pointers for future communication with employees with particular emphasis on clarifying on any point of gross misunderstanding in respect of ESOP or Company’s growth prospect.
- Achievement of retention and performance objective – The Company should evaluate whether their primary objectives of implementing an ESOP have been achieved, like, whether ESOP has an impact on their retention policy and whether employees are motivated enough to achieve the corporate performance.
- Knowledge and awareness about ESOPs Offered – A Company should know whether Plan participants are aware of the ESOP terms, the pros, cons and risk involved while accepting an offer and on allotment of shares. They should understand their rights, liabilities and the events which could help in better monetization of their ESOPs. Lack of understanding of the ESOP plan and inadequate knowledge about Company’s growth prospects (as impacts equity valuation) periodically may loose sheen of ESOPs in the eyes of employees; even though ESOPs would be highly valuable. Perception matters. The test here is to know whether employees are conscious that they are carrying valuable rights capable of giving them even a windfall.
- Motivation Level – The motivation level of employees carrying ESOPs is another measure to know whether ESOPs are working. This can be tested particularly after commitment of ESOPs by measurement of individual and corporate performance goals.
- Wealth creation – This is one of the important factors of success of any ESOP Plan particularly in an unlisted Company. A periodic or regular wealth creation opportunity or provision of liquidity event makes ESOPs work better which keeps existing employees’ expectation intact and brings the belief of new joinees’ in the ESOP reward mechanism. The employees can calculate the intrinsic value (wealth created) in their outstanding options with reference to value discovery in these liquidity events.
These points are not exhaustive, and a Company may have more measures to evaluate the effectiveness of the ESOP plan depending upon the plan terms, employees covered, etc. Companies should evaluate their ESOP plans periodically to test to what extent ESOPs are working and to plan for any corrective measures.
With his strong background in accounting and advisory, Rahul has been instrumental in conceptualizing and designing over 200 equity compensation Plans for companies of all sizes from start-ups to established conglomerates.
He has also advised companies in IND AS transition with respect to options valuation and accounting, re-pricing and other corporate actions such as mergers and de-mergers.