Published Editorial

Evaluating stock options

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EY - Evaluating stock options

Stock options have become one of the preferred methods adopted by companies to reward employees beyond a certain seniority level in India. Not only does this help establish a correlation between the employee’s performance and that of the company (measured in terms of improvement in market value), it also helps in reducing the actual cash outflow from the company on account of employee compensation. In some cases, employees stand to make much more by selling shares allotted to them by the company than their fixed cost-to-company salaries.

While stock-based incentives for employees are quite popular in other countries as well, there are certain key differences in the way Indian firms and their multinational counterparts approach the subject.

A report by consulting firm EY says that Indian companies allocate a much lower percentage of their share capital than multinational corporations (MNCs) towards stock-based incentive programs for employees. According to the EY report, around 47% of Indian companies have committed only up to 3% of their share capital towards stock-based incentive plans. On the other hand, a large share of the MNCs—one-third of them—have committed 5-10% of their share capital for similar purposes. At the top end, about 9% of MNCs have committed more than 15% of their share capital towards stock-based remuneration programs, whereas no Indian company has done so.

Not only the quantum of share capital, but the mix of schemes through which employees are rewarded in stock also differs for Indian companies vis-à-vis global ones. An overwhelming 88% of Indian companies prefer the traditional employee stock option plan (ESOP)—which involves granting stock options to employees that vest over a period of time. Upon vesting, these shares have to be purchased from the company by the employee, who can later sell them in the open market when the price rises. However, only 49% of MNCs roll out ESOPs. The other methods preferred by them to reward employees through stocks include stock appreciation rights (which are settled in cash and do not lead to dilution of the share capital of the company) and employee stock purchase plan (which is used to reward past performance and entails employees purchasing shares at a discounted price); and often a combination of all three.

Two industry professionals offer their perspectives on the subject:

SONU IYERPartner and National Leader (Human Capital Services) at EY

“Indian companies preferring ESOP over other plans is not a better or worse practice per se, but more about what is popular and easy to understand in India,” says Iyer.

“The word stock option has its own perceived magic of promise of wealth, a carrying forward of the frenzy created by technology companies when stock-based compensation first came into fashion,” she says.
Iyer, who authored the EY report on stock-based incentives, says these stock-based incentive plans aim to serve the dual purpose of promoting corporate performance and creating wealth for the employees. She adds that both employer and employee-related factors are the key reasons for implementing stock-based incentive plans.

“Such plans aid the companies in retention and attraction of key talent with critical skills and help the employees in motivation, reward of performance and wealth creation. With the increased focused on stock-based incentive compensation, companies will see an increase in corporate performance due to increased performance of the employees,” she says.

Iyer says stock-based incentive plans are being used mostly by start-up firms or by unlisted companies who plan to go in for an initial public offering in the near future in order to create wealth for the employees once the company lists. In the past, information technology companies pioneered the trend of stock-based incentive plans in India and they are the ones who still continue to lead in this.

“Several companies in other sectors such as manufacturing and consumer goods, life sciences, and banking and financial services are rolling out stock-based incentive plans for their employees,” adds Iyer.

ADIL MALIAGroup President (Human Resources) at Essar group

While there may be comparative data points regarding the quantum of share capital that Indian firms and MNCs allocate to stock-based incentive for employees, there is no theory as such which explains this. It depends on several factors like the economic state of the country in which the company operates and in which the employees are based, and whether firms approach growth from a long-term value creation perspective or with short-term objectives. In the history of compensation science in India, companies typically prefer to pay remuneration to employees “here and now”, without much scope for future speculation.

Companies in the West may also prefer to allot more stock-based incentives to employees through a mix of various mechanisms like ESOPs and stock appreciation rights, since the tax laws of some of these countries like the US and the UK incentivize investments in stocks as they eventually lead to capital creation. In India, the history of employee stock options isn’t old enough for people to truly realize their potential. For employees to realize true value creation through stock options, it takes at least 8-10 years. However, in the last three years, the economy has been in the doldrums and most of the stock options are under water, making this instrument somewhat less attractive.