PROCEDURAL ASPECTS OF EMPLOYEE STOCK OPTION SCHEME
Employee stock option scheme is relatively a new concept in India. ESOP’s dates back to 1950, an investment banker of Louise Kelso (U.S.A.) stated that “the capitalist system would be stronger if all workers, not just a few shareholders, could acquire an ownership interest in companies where they are employed” It marked as a beginning point for schemes like employee stock options. In Japan these systems were brought in the year 1997 and corporations have increases the amount of ESOs in the recent years. We have discussed history of ESOPs previously and in this part we need to focus on the procedure of ESOPs and how they are granted, kinds of ESOPs and other matters relating to grant procedures.
Kinds of ESOPs
Incentive Stock Options – These stock options are given to C-suit executives or the top managerial employees with an intent to increase the share prices which in turn also benefits the employee. To understand this increase we can refer the following example. Company A hires a CEO and offers him an option to buy 10,000 shares 2 years later at a price of rupees 200 while the current price is rupees 150. Now the CEO has an opportunity to work efficiently and push stock prices within 2 years to a value of rupees 300. If he succeeds in pushing up the prices then he will earn a profit of rupees 10 lakhs. These stock options acts as an incentive and yields maximum output from employees.
Stock Appreciation Rights – In such a scheme, the entire transaction is fictional, and every employee simply gets an amount equivalent to the appreciation in the stocks granted to her under the ESOP-without any shares actually changing hands. This practice is widely used in companies like Procter and Gamble, Motorola, PepsiCo etc. Under this, an employee is awarded a Stock Appreciation Right (SAR) and is given the amount by which the stock appreciates at the time when the SAR is used. Example: an employee is given a SAR today when the price is rupees 70. If the SAR is utilized after five years when the price is rupees 190, each SAR is worth rupees 110.
Employee Stock Purchase – Third kind of stock option is given under option called as an Employee Stock Purchase (ESP) scheme. This should be issued to all employees, but temporary employees, interns and those who have been with the company for less than two years can be left out. In an ESP scheme, a stock option can be distributed at a price that is at least 85% of the present market price or more. Thus, if the present market price is rupees 100, the company can give an offer to its employees to buy shares 3 years later at a price of rupees 85.
Practices prevalent in India
First category of stock option plan is the scheme under which the employee is directly given shares by the Company either at present market price or at a lower concession price. Source of procurement may be own funds of the employee or credit from the bank company or any other financial institution
Second category is where the employee has a choice to acquire warrants, debentures or shares of the Company at the market price or at a concessional price which is significantly lower than the market price. When the purchase is made then there is a standby or consigning period when the employee has to wait to execute his option. After this is the ‘Operation-Period’ during which the employee can execute the option to pursue allotment of securities, warrants shares etc. which are converted into shares at a pre-decided price. There is also a variation in which, bonus is accumulated or not given whereas in other variant bonus shares are given to employees as soon as they are issued.
Generally there is a lock in period during which the employee cannot sell his shares. It is done to maintain positive interest of employees in the company.
Third category is ‘Stock Appreciation Rights’ which we have discussed earlier. A specific number of shares are fictionally given to him at a specific price. At the end of a predetermined period, the price of the shares is noted and if the price has elevated then the difference is paid to him by the Company.
Recipients of Stock Options
Stock Options are given as an incentive or a reward to employees hence there are criteria which needs to be fulfilled to qualify as a recipient of a stock option. Though stock options can be given without a criterion also but generally companies set a guideline or qualifying criteria to receive such benefits.
1. Service Time period- Loyalty of employees is rewarded by taking seniority as a criterion for ESOPs. The length of employment and experienced gained are important criterion in companies where turnover rates are high and loyal employees are often give stocks to acknowledge them and retain them for further growth of company.
2. Cadre of Employees- While picking up employees for ESPOs one needs to take into account the criticality and market value of a cadre post. Strategists have classified employees into two categories. The differentiation is needed because it is b. The first categories comprises of those employees which have imperative role and functions and are indispensable assets for the company. This class of employees helps in maintaining the competitive advantage of the company. The second class contains employees who are substitutable as they functions as a body of the company and workforce in this cadre can be replaced easily without any special requirements. Hence the first class of employees is taken into consideration while awarding ESPOs.
3. Performance- Work performance and target achievement is one of the essential criteria while awarding ESPOs hence the best performers in the company become the shareholders. ICICI bank has followed this criterion and takes into account completion of pre set targets, technical knowledge and overall performance while granting ESOPs to their employees. These bars are set high and acts as a positive force to get most out of the employees. It motivates employees to prove themselves as an indispensable asset for the company and to maintain the set standards.
4. Size of the Company- While granting ESOPs to its employees a company has takes into consideration the size of the body corporate as a large company cannot enjoy the luxury of granting ESOPs to each and every employee. Whereas some companies with limited corporate structure awards ESOPs to every employee to retain the efficiency of the workforce. We can consider example of Aditi Technologies which is a Bangalore based Software Company which has granted stock options to all of their employees as their corporate structure is fit for using such schemes.
Procedure
All companies (listed, unlisted, private or public) are allowed to issue Sweat Equity Shares. But they need to follow the procedure prescribed in Section-79A of the Companies Act.
For listed companies, SECURITIES AND EXCHANGE BOARD OF INDIA (SHARE BASED EMPLOYEE
BENEFITS) REGULATIONS, 2014 is to be complied. These regulations are as following
Administration and Implementation
16. (1) Subject to the provisions of these regulations, the ESOS shall contain the details of the manner in which the scheme will be implemented and operated.
(2) No ESOS shall be offered unless the disclosures, as specified by Board in this regard, are made by the company to the prospective option grantees.
Pricing
17. The company granting option to its employees pursuant to ESOS will have the freedom to determine the exercise price subject to conforming to the accounting policies specified in regulation 15.
Vesting period
18. (1) There shall be a minimum vesting period of one year in case of ESOS:
Provided that in case where options are granted by a company under an ESOS in lieu of options held by a person under an ESOS in another company which has merged or amalgamated with that company, the period during which the options granted by the transferor company were held by him shall be adjusted against the minimum vesting period required under this sub-regulation.
(2) The company may specify the lock-in period for the shares issued pursuant to exercise of option.
Rights of the option holder
19. The employee shall not have right to receive any dividend or to vote or in any manner enjoy the benefits of a shareholder in respect of option granted to him, till shares are issued upon exercise of option.
Consequence of failure to exercise option
20. The amount payable by the employee, if any, at the time of grant of option, –
(a) May be forfeited by the company if the option is not exercised by the employee within the exercise period; or
(b) May be refunded to the employee if the options are not vested due to non-fulfillment of conditions relating to vesting of option as per the ESOS.
Guidelines for Employee Stock Purchase Scheme (ESPS), Stock Appreciation Rights Scheme (SARS) and General Employee Benefits Scheme (GEBS) have also been given in the SEBI 2014 regulations but only ESOS has been discussed in this project to justify the objectives of the project.
HDFC Employee Stock Options Scheme (United States)
To deal with the practical aspect of ESOS we can refer the stock options scheme formulated by HDFC bank and it contains following rules and procedures.
Compensation Committee – The bank forms a compensation committee for granting ESOPs. This committee decides upon matters of grant with respect to rules and regulations formulated by the members of the bank in the annual general meeting. The decisions of the compensation committee are binding and final with respect to any clarifications or grants which are to be made to the employees.
Eligible Employees – All Employees are eligible for the Grant of the Options. The total number of Options issued pursuant to this ESOS will be subject to a maximum of 10,000,000 (10 million only) Options. On exercise of the Option in accordance with this ESOS, One Equity Share for each Option held by the Employee would be issued by the Bank. All Employees to whom the Compensation Committee has resolved that the aforesaid Options be granted would be informed of the same by way of a separate communication by way of a separate letter or by way of an electronic mail.
Criteria – The compensation committee looks into factors like merit, performance, grade and future contributions while granting stock options. The committee has also power to deny a grant if the preceding appraisal of the employee has been marked as unacceptable.
Vesting Options – These are in two stages which are as following:-
STAGE I
50% of the Options rounded off to the nearest 100 shall Vest in the Employees on the 27/06/2008
STAGE II
Balance Options shall Vest in the Employees on 27/06/2009
Various other procedure are also followed by the HDFC bank as stated in the bank regulations and have not been discussed in this project to skip out irrelevant portions and adhere to the page limits.