No More the Honey

My team and I work nearly 60 hours a week to finish my project in time. The

exercise saves a good Rs 2 lakh for the company and what do I get? A five-figure

salary that I would have got irrespective of any extra work…

It was this angst that IT companies addressed when they started offering

employee stock options a few years ago. During the heady days, when a smattering

of IT job openings greeted every techie, the system worked beautifully.

Employers used ESOPs as an effective tool not justto attract the best talent but

also to cut down attrition rates.

But after the stock market crash, most of these options have slipped

underwater. Yet, companies have not found it necessary to address the situation.

Among 28 of India’s larger IT companies surveyed, only 23% offer ESOPs to more

than 90% its employees. The number is as high as 60% in the case of smaller

companies. A significant 54% of larger companies offer ESOPs to under 25%

employees

A report ‘ESOP Design Practices 2001’ based on a survey of 40 companies

across the country shows that a whopping 92% of these companies, both IT and

non-IT have not changed their policies regarding ESOPs despite the fall in stock

prices. Of this, 55% have not addressed the situation in case of an acquisition

and 50% have not catered for rights issues and consequent diminution in the

value of stock options.

The report by ESOP Direct, a subsidiary of Pune based Kirtane Pandit ESOP

Consulting, covers 12 non-IT companies and 28 IT companies. ESOP Direct is an

end-to-end solutions provider. "The survey was sought information on the

trends and practice of ESOPs," says Harshu Ghate, managing director, ESOP

Direct. Ghate admits that while ESOPs are fairly new in India, there is data

available from the US where stock options are part of a well-accepted practice.

Says Ghate, "More than 95% of ESOPs in India were given as an additional

benefit apart from the salary. So the ESOP recipients have not lost out on their

salary to that extent. It is only those who exercised their options and held on

to them in anticipation of prices going up, who would have lost out. If

employees consider ESOPs as an incentive, they should sell them off immediately.

If they hold on to them, they become investors and it means taking all the

market risks that come with an investment. There is no point in blaming the

companies and giving ESOPs a bad name. This is the first time Indian IT

professionals have witnessed the industry facing a slump and thus the despair in

prices going down."

It is true that with the current slump in the stock markets, many of the

options issued by the companies are under water i.e. market price is lower than

the exercise price. However, the slump is a blessing in disguise for companies

as the current prices are the lowest at which the options could be issued.

Therefore if options are issued at current market prices, there would be no

accounting charge for the company and no downside risk to the employees.

Ghate points out that companies often create the impression that their

employees will gain substantially from their stock options. This is misleading

for employees. In fact, the whole objective of ESOPs is to integrate the goals

and fortunes of employees and shareholders. Once the employees become part

owners of the company, they cannot say that they want only the up side of the

ownership (appreciation in value) and not the downside (fall in the value).

Unfortunately, ESOP benefits have been marketed in India as a sure way of making

mega bucks.

The survey reveals that Indian recipients of ESOPs have not yet realized that

ESOPs are actually incentives. Instead of encashing them on the day of

allotment, they hang on. If they hold on, they take an investment decision,

exposing themselves to market risk. Ghate explains that in the US, ESOPs are

usually encashed the very same day.

Far more important is the fact that companies who have offered ESOPs have not

paid attention to important issues like what happens when the company gets

acquired, or when (as is happening now) markets are down and so are prices.

Another situation that is not addressed is of companies going in for a rights

issue. "Change in control through takeovers, mergers and de-mergers, are no

longer stray incidences. It is the same with companies issuing rights and bonus

shares. It appears that Indian companies leave it to the compensation committees

to decide on the impact as and when such situations arise. Over 30% high-tech

companies have re-priced their options in the US," says Ghate. He feels

that when market conditions are down, as they currently are, ESOPs should either

be re-priced or increased.

What has also emerged in India is that there is no difference

between how IT and non-IT companies view ESOPs. While retention, rewarding

performance and facilitating employee ownership were the objectives of the ESOP

plan, the survey found no differences between sectors or in the categories of

target employees.

The survey found that 42.5% Indian companies, across the IT

and non-IT spectrum, offered ESOPs at a fair market price, 22.5% offered these

at below market prices. This compares favorably with the global trend of 99.7%

offering at equal to fair market price and 2.3% below fair market price.

"Global trends reveal that there is a segment which offers at above fair

market price but this could be attributed to mature markets. When the markets

were rising rapidly (at say 40%), companies could offer options 20% above the

market price and still stay ahead", Ghate points out.

What emerges is a strong need to inform employees about the

downside of holding stock options just as they are told about the benefits.

Options should be looked upon as an instrument that gives part ownership of the

company to the employees, as it carries responsibilities and risks alike.

Methodology

The survey on ESOPs was carried out in 40 Indian companies.

These included 28 IT companies and 12 non-IT companies across the country. These

companies were shortlisted from a base of 150 companies who have implemented

ESOPs.

These 40 companies were classified on the basis of–status

(listed or unlisted), sector (IT or non- IT), company size (large or small) and

year of ESOP implementation (before or after 2000).

IT companies encompass all those involved in IT services,

manufacturing and products. The distinction between large and small IT companies

were on the basis of turnover and overall size of operations. For small

companies, the turnover was cut off at Rs 200 crore. The turnover for large

companies is Rs 500.

Companies like Infosys Technologies, Aptech Limited, KPIT

Systems, Mahindra British Telecom, Mascot Systems, Mastek, Onward Technologies,

Onward Technologies, Persistent Systems, Rolta India and Tata Infotech

participated in the survey.

Case study

Here’s an example of a software company that has granted

options to its employees.

With its prime focus on Embedded Designs, Company X is a

single source provider of software design expertise from concept to end product.

It has clients across Europe, the United Sattes and the South-East Asian

countries.

The company was in its start up stage and the management

wanted to use ESOPs to enhance employee performance, retain good performers as

well as attract new talent. All employees in the company were eligible for stock

options. Junior level employees would be entitled to receive options if their

performance fell into a particular category predefined by the management. These

options were granted to them at almost 50% of the fair market value. Senior and

middle-level employees were granted different types of options at close to 25%

of the fair market value.

There were different options granted to attract new talent at

the senior level. At 25% of the fair market value, the benefits passed on to

employees through these options were almost twice the gross annual salary.

However, in order to retain these senior employees, the period set to vest these

options was comparatively longer than the period of the options granted to other

employees. The benefits to be passed on from the options granted to senior,

middle and junior employees, were close to a year’s gross annual salary.

As compared to other companies, this company had diluted a

larger portion of its equity base to be granted as options. It was close to 20%

of the total share capital. As an exit route the company also provided for Intra

Employee trading as one mode, where the company would announce the floor price

at regular intervals.

However, as has happened with several infotech companies as a

result of the slowdown, the company has postponed its IPO indefinitely and is

not currently listed on the stock exchanges. The name of the company has been

witheld due to its agreement on confidentiality with ESOP Direct.

Nanda Kasabe CNS, in

Pune