Who should be covered under ESOPs?

ESOP or any Equity based compensation instrument is more complex to understand than any other mode of compensation. At the same time, being a costly instrument, it needs to be used carefully. Simple answer to – who should be covered? is that give it to those who understand it and appreciate its value.  This question can be answered from several viewpoints.

The most common reasons why companies give ESOPs are attraction, retention and incentivization of talent, encourage employee ownership and share the wealth generated. Who should be covered can be answered if we relate it to the reasons for which they are given. Depending on the objective you should offer ESOPs to those whom you want to attract (may be at lower pay than what they are worth) or whom you want to retain for a longer term or whom you want to incentivize over and above the normal pay.  ESOPs are usually used as a differentiating component of compensation. If you wish to differentiate between to employees of the same role or designation, you may not have much leeway in the compensation slabs. Companies should carve out a well-defined and transparent selection criteria to avoid favoritism.  Here ESOPs, which are discretionary in nature, can be leveraged.

Since ESOPs aim at ensuring sustained long-term performance, they should be given to those who will ensure this is achieved.  If the aim is to facilitate broad based employee ownership (every employee should feel like an owner), the coverage has to be broad based, virtually everyone in the organization.

One of the most under communicated aspect of ESOPs is lack of certainty about realization of benefit. Benefits are linked directly to increase in Valuation of companies and not necessarily its performance. There are several examples of Company doing well in performance but not necessarily on Stock market valuations and vice versa.  Equally important to appreciate is existence of business cycles and related uncertainties and ups and downs. It is important to cover only those employees who understand these realities. If this lack of relationship is not understood, absence of benefits in spite of performance will only be counterproductive and harm the spirit of introducing the Plan.  On the other hand, those who do not understand and appreciate the value and limitations of ESOPs are also those who would prefer cash in hand (liquidity) over shares with uncertain liquidity.

Decision about coverage is also linked to the available pool. A limited pool can service fewer employees for a longer period or a larger group for a short period. Given that it is a long-term incentive instrument, sustaining the pool over a longer duration should be a preferred alternative.

Many companies make a mistake of covering more in the initial euphoria and later finding it difficult to sustain the coverage because of insufficient pool. It is always easier to increase the pool later rather than discontinuing an incentive once given.