employee stock option plan-nn akhouri 30 8 07

8/6/2019 Employee Stock Option Plan-NN Akhouri 30 8 07

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Employee Stock Option PlanEmployee Stock Option Plan

An OverviewAn Overview

N. N. AkhouriSr.VP-HRM

Hero Honda Motors



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The flow..The flow..Concept of ESOPConcept of ESOP

Trend of ESOPsTrend of ESOPsEmployer experienceEmployer experience--Some factsSome facts

Type of ESOPsType of ESOPs

Governance IssuesGovernance IssuesInfosysInfosys and Dr. Reddy Lab Exampleand Dr. Reddy Lab Example

TaxabilityTaxability

Disadvantage of ESOPDisadvantage of ESOPFuture of Stock optionFuture of Stock option



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Concept of ESOPConcept of ESOP

In vogue for over a decade in India.In vogue for over a decade in India.

Definition according to SEBI Definition according to SEBI ““Plan under which companyPlan under which companyprovides options to the employees the benefit or the right toprovides options to the employees the benefit or the right to

purchase at a future date the securities offered by thepurchase at a future date the securities offered by thecompany at a pre determined pricecompany at a pre determined price””..

Introduced initially in technology based companies and nowIntroduced initially in technology based companies and now

spread over Pharmaceutical, Communication,spread over Pharmaceutical, Communication,Entertainment, information technology sectors.Entertainment, information technology sectors.

In 1992, only One million employees held stock options,In 1992, only One million employees held stock options,

mostly managers and executives. By midmostly managers and executives. By mid--1990s, growing1990s, growingsteadily over the decade to 10 million.steadily over the decade to 10 million.

Infosys, HLL, WIPRO, Polaris, Dr Reddy,Infosys, HLL, WIPRO, Polaris, Dr Reddy, RanbaxyRanbaxy,,WockhardtWockhardt,, LupinLupin, Gillette, Gillette………….have introduced this..have introduced this.



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MethodologyMethodology

Grant of options to the employees.Grant of options to the employees.

Employees can convert the options in to shares at a preEmployees can convert the options in to shares at a predetermined price.determined price.

Disposal of share in the market after a specified period of Disposal of share in the market after a specified period of time as stipulated by the company.time as stipulated by the company.

Exercise price (price which the employee is required to pay)Exercise price (price which the employee is required to pay)or the intrinsic price ( difference between market price andor the intrinsic price ( difference between market price andexercise price).exercise price).



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Global TrendGlobal Trend

RussiaRussia: Average ownership by non management employees: Average ownership by non management employeesis between 50%is between 50%--60%.Employees prefer to hold the stock60%.Employees prefer to hold the stock

than sell them.than sell them.ChinaChina: Many enterprise have offered ESOP. Several local: Many enterprise have offered ESOP. Several localcompanies have sold their enterprises to the employees.companies have sold their enterprises to the employees.

UKUK: Has been in place since 1980s. Aims at broad: Has been in place since 1980s. Aims at broadownership of the employees.ownership of the employees.

US:US: Started in the late 70s. Several enterprises whereStarted in the late 70s. Several enterprises where

employees hold 2employees hold 2--3% in the firms.3% in the firms.



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Employer ExperienceEmployer Experience …………some factssome facts

According to survey conducted by Hewitt the following were According to survey conducted by Hewitt the following werethe findings:the findings:

Companies which had ESOP had a greater ROA (return of Companies which had ESOP had a greater ROA (return of asset) compared to industry peer group.asset) compared to industry peer group.

Greater total Shareholder return compared to peer group.Greater total Shareholder return compared to peer group.

Greater employee impact on the Business results.Greater employee impact on the Business results.

Looking at 345 companies world wide ,Looking at 345 companies world wide , 69.6% survived 69.6% survived through 1999through 1999, compared to, compared to 54.8% of the non54.8% of the non--ESOP ESOP matchesmatches. "Survival" here means continued to do business. "Survival" here means continued to do businessas the same entity. Closing, sale, or merger wouldas the same entity. Closing, sale, or merger wouldconstitute nonconstitute non--survival.survival.



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Types of ESOPsTypes of ESOPs

OptionOption: Right of the employee to buy or sell the shares at a: Right of the employee to buy or sell the shares at apre determined price and predetermined date.pre determined price and predetermined date.

Restricted StockRestricted Stock: Shares given with vesting conditions.: Shares given with vesting conditions.(Vesting percentage refers to that portion of total options(Vesting percentage refers to that portion of total optionsgranted, which you will be eligible to exercise. Vestinggranted, which you will be eligible to exercise. Vesting

period is the period on the completion of which the saidperiod is the period on the completion of which the saidportion can be exercised)portion can be exercised)

Stock appreciationStock appreciation: The employee receives the net amount: The employee receives the net amount

of the increase in the stock price.of the increase in the stock price.



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Governance IssuesGovernance Issues

ESOPs to be approved by the shareholders during theESOPs to be approved by the shareholders during themeeting.meeting.

ESOPs can be issued for ADR/GDR or securitiesESOPs can be issued for ADR/GDR or securities

convertible in to shares.convertible in to shares.Minimum period of 1 yr between grant of option and theMinimum period of 1 yr between grant of option and thevesting period and a max period of 8 yrs.vesting period and a max period of 8 yrs.

The scheme to be administered through the compensationThe scheme to be administered through the compensationcommittee.committee.

Taxed as a benefit, recovered from the employee.Taxed as a benefit, recovered from the employee.

Accounting of the stock option happens at the time they are Accounting of the stock option happens at the time they aregranted to the employees.granted to the employees.

Company to have a taxable expense at the time when theCompany to have a taxable expense at the time when the

employee sells the stock.employee sells the stock.



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Governance IssuesGovernance Issues

Board of Directors to disclose the following information:Board of Directors to disclose the following information:

Total number of shares covered by the ESOP scheme asTotal number of shares covered by the ESOP scheme asapproved by the shareholders.approved by the shareholders.

Pricing FormulaePricing Formulae

Options grantedOptions granted

Options exercised.Options exercised.

Employee wise details of options granted to the personnel.Employee wise details of options granted to the personnel.

The accounting value of the options to be treated asThe accounting value of the options to be treated asemployee compensation in financial statement.employee compensation in financial statement.



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Example: InfosysExample: Infosys

One of the first companies to introduce ESOPOne of the first companies to introduce ESOP

Objective:Objective:

*Wealth creation opportunity .*Wealth creation opportunity .

*Long term reward proposition.*Long term reward proposition.

ESOPESOP --1999 plan1999 plan1.1. If the employee leaves before the lock in period, the shares areIf the employee leaves before the lock in period, the shares are sold back to thesold back to thetrust.trust.

2.2. Vesting pattern is back loaded and is fairly long term:Vesting pattern is back loaded and is fairly long term:

a)1a)1stst

yr yr --10% return10% returnb)2b)2ndnd yr yr -- 20% return20% return

c) 3c) 3rdrd yr yr --30% return. (Black30% return. (Black ScholesScholes valuation method) :valuation method) :

4.4. Expected life:2Expected life:2--5 yrs.5 yrs.

5.5. Risk free interest: 6%Risk free interest: 6%

6.6. Volatility: 60%Volatility: 60%--70%70%

7.7. Dividend yield: 0.2%Dividend yield: 0.2%

8.8. Have opted for the ESOP trust which obtains its funds by way of Have opted for the ESOP trust which obtains its funds by way of loan and thenloan and thenallots the shares to the employee.allots the shares to the employee.



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Example: Dr. Reddy LabExample: Dr. Reddy LabRationale for introducing ESOP:Rationale for introducing ESOP:

– –

Retention,Retention,

– – Wealth creation and Wealth sharing,Wealth creation and Wealth sharing,

– – Rewarding High PerformersRewarding High Performers

The lock in period is one year after which the employee can exer The lock in period is one year after which the employee can exer cises 25% of thecises 25% of theoptions every year.options every year.

Has been implemented so as to cover about 25% of employeesHas been implemented so as to cover about 25% of employees

The Result :The Result :

The company has not been able to fully achieve the intended objeThe company has not been able to fully achieve the intended objective of employeective of employee

retention through ESOP.retention through ESOP.

Most employees during switch (from one Company to another) are aMost employees during switch (from one Company to another) are asking for the 'lostsking for the 'lostvalue in not exercising options' to be reimbursed by the hiringvalue in not exercising options' to be reimbursed by the hiring Company.Company.

Internally , employees have rated 8/10 for ESOP...amongst variouInternally , employees have rated 8/10 for ESOP...amongst various employee rewards employee rewardrecognition mechanisms...including PMS.recognition mechanisms...including PMS.

The problem has a unique dimension with respect toThe problem has a unique dimension with respect to PharmaPharma companies since thecompanies since the

FBT for employee related benefits and expenses is different in tFBT for employee related benefits and expenses is different in this sector.his sector.



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Disadvantage of ESOPsDisadvantage of ESOPs

Any fluctuation in the market prices Any fluctuation in the market prices……. there is a tendency. there is a tendency

to offload the ESOPs.to offload the ESOPs.It defeats the very purpose of:It defeats the very purpose of:

– – Ownership (as employees sell the allotted quota);Ownership (as employees sell the allotted quota);

– – Retention (as employees switch jobs and get compensated for Retention (as employees switch jobs and get compensated for the lost value by the new employer);the lost value by the new employer);

Inbuilt uncertainty due to fluctuating stock prices.Inbuilt uncertainty due to fluctuating stock prices.

When the stock prices go down, ESOP becomes worthlessWhen the stock prices go down, ESOP becomes worthless

paper paper



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Future of Stock optionFuture of Stock optionIncreasing volatility in stock marketIncreasing volatility in stock market …….beyond companies.beyond companies

control .control .

Employee stock purchase planEmployee stock purchase plan--ESPSESPS (plan under which(plan under whichthe company offers shares to employees as part of public the company offers shares to employees as part of public

issue or otherwise)issue or otherwise) preferred to ESOPs which providespreferred to ESOPs which providesimmediate gratification.immediate gratification.

Need to develop innovative and secure options for Need to develop innovative and secure options for

employeesemployeesESOP in combination with other reward to be looked as aESOP in combination with other reward to be looked as aholistic measure.holistic measure.



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Thank YouThank Youfor your attentionfor your attention

employee stock option plan-nn akhouri 30 8 07

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