The pricing, as they say determines the success or failure of any product and so is for Employee Stock Options (ESOPs). Pricing of ESOPs termed as grant price/strike price/base price/exercise price depends upon basic objective(s) of the Company granting the options. It also depends upon various parameters like who is the proposed grantee, past performance, loyalty, service tenure, the pay structure, existing as well as future employee’s expectations from ESOPs and most importantly the benefit to be derived out of ESOPs.

 

Let us look at this issue from all possible angles – legal, strategic, stake holders and market trends.

 

  • The Companies Act, 2013 states that a company is at liberty to determine the grant / exercise price subject to the fact that minimum of face value of the equity should be collected before allotment of equity. Accounting standards (IGAAP) prescribe that the Discount to market price should be charged to Profits over the vesting period. There are no Tax implications with respect to different pricing alternatives.

 

  • Strategically, how much the employee should pay for the shares is a function of the objective. If one is rewarding past performance, issue at Discount to market price can be justified. However, if it is for rewarding future performance, then grant at market price makes more sense. If the objective is to provide some safety net (protection from market fluctuations), issue at a discount can serve the purpose.

 

  • From the stakeholders’ perspective, Regulators are indifferent; shareholders will not normally encourage Discount unless the Plan is broad-based. They will expect employees to take same risk as them. Employees will always prefer Discounts to ensure some intrinsic value and protection from market volatility. The challenge is in keeping all the stakeholders happy.

 

  •  Market trends, till recently, were clearly towards the issue at Market price. In recent years, Companies have explored with Discounts (even up to Face value) mainly to take care of dilution constraints.

 

Usually, while granting ESOPs to the employees who are associated with the organization for a longer period or say are founding employees, they are generally given a discount to the Market Price to create some wealth on the day of grant itself and to withstand any fluctuation in future. Discount results in lesser equity dilution as the benefit per Option goes up. However, when new talent is hired, companies generally grant ESOPs at Market price so that the hire is eligible for wealth creation basis the future growth of the Company due to his contribution.

To conclude, exercise price can be theoretically any value above the face value of the equity share. Still, practically, a careful examination is done in respect of the objective(s) behind the grant, the dilution appetite of owners, expected benefit per ESOP, the accounting implications, and potential tax savings out of accounting cost.

 

 

 

Author
Shefali CA Shefali Lotia is a Company Secretary, working with ESOP Direct as a Consultant in Equity Compensation Solutions team since 2017. She has a 12 years of work experience in various fields including accounting, taxation, legal and equity compensation plans.