Employees’ Stock Option Plan (ESOP) might have had its origins in the US IT sector but it had long ago penetrated the Indian IT sector as well so much so that stories of Infosys’ drivers and peons striking it rich have come to sound old and dated. It is back in the news because recently a relatively low-profile company Coforge had to increase the ESOP pool by 1.9 million shares after presumably exhausting them.
ESOP as an employee retention tool has been traditionally associated with higher echelons of a company where normally key talent resides but Infosys showed that it can be democratically offered across the board including to the rank and file.
How does ESOP work
A listed company offers a specified number of its shares to its employees on the condition that it will vest in them only after a specified number of years, say three. The minimum vesting period as per the SEBI norms is one year. Unlisted companies are not bound by the SEBI norms. If they quit before completing the vesting period, they will not get the shares.
There is now an alignment of employee interests with those of the company he works for— he will give his everything to make the company succeed in terms of profits and growth. In other words, his growth and prosperity lies in the growth and prosperity of his employer. Dividend from his holdings can be astronomical if both perform well and market price will correspondingly soar giving rise to handsome capital gains on sale of such shares by the employee. So, ESOP is an excellent retention and reward tool insofar as employees are concerned. Indeed, one couldn’t have thought of anything better.
Now comes the nitty gritty. Section 62 of the Companies Act, 2013 seeks to protect the rights of existing shareholders from they getting diluted. Therefore, the norm is rights issue — if a public company seeks to increase its subscribed share capital, it has to make offer of shares in proportion to his existing holdings.
To wit, if a company has already issued one crore shares of ₹10 each and I hold 1000 shares out of these, my stakes are just 0.0001 but that doesn’t mean my rights can be trifled with. So, should the company seek to double its capital by issuing another one crore share, each shareholder will get letter of offer that entitles him to subscribe to additional shares so that his inter se rights remain intact.
Accordingly, I would get a letter entitling me to subscribe to another 1,000 shares at the price fixed. Two things must be noted however. First while the company is bound to offer, I am not obliged to accept. But I am not allowed to play dog in the manger. If I don’t want, I can renounce all the 1000 shares or any part of it to anyone of my choice.
Alternatively, I can make money by selling the offer letter in the market which is win-win for both me and the buyer — if the offer price is ₹60 per share whereas its market quotation is ₹150, we can share the spoils. I sell the rights @ ₹ 40 per share and get ₹40,000 without expending anything. The buyer gets to buy 1000 shares @ ₹100 per share (40 to me and 60 to the company) whereas in the market would cost him ₹150 per share in the market.
Secondly, the law on rights issue isn’t cast in stone. A thaw is provided by section 62 itself— if a company passes a special resolution, rights offer can be bypassed in favour of others. This happens when a foreign collaborator has to take up a stake in the company or a machinery or technology supplier prefers equity of the company instead of cash. And more importantly, it happens when a company goes for ESOP.
As far as accounting is concerned, if the price at which the shares are allotted to the employees on the vesting date corresponds to its market price. There is no element of salary in the transaction whereas should there be a concession vis-à-vis the market value such concession would constitute a perquisite and taxable as such in his hands. Such perks correspondingly can be booked as employee cost or salary by the employer.
Do ESOP makes a dent in the share value
Any discussion on ESOP would be incomplete till we address the moot question if it makes a dent in the share value. The conservative view is repeated marginalisation of the shareholders by offering shares to outsiders including the employees devalues their investments especially when the full fair value of the shares allotted to employees is not recovered from them and the larger number of shares reduces the earnings per share (EPS).
But the debate is never-ending because the progressive view is ESOP keeps the morale of the employees high and thus produces a virtuous cycle. The truth is ESOP must be attractive to the employees and if in the process the shareholders are forced to make sacrifice, in the long run such a sacrifice adds and not detracts from the net worth of the shareholders. At any rate, the shareholders have to grin and bear when they pay directly (through concession in pricing) or indirectly (by being kept out of the benefits of rights issue) for retention of employees.
At any rate rights issue i.e., the existing shareholders continuing as the existing shareholders for all times to come is not a pragmatic but counterproductive vision sustainable only in closely-held companies. In large listed companies, such insularity and incestuousness may prove to be counterproductive. Old or original shareholders have to yield and sacrifice in favour of collaborators, technology suppliers and talented employees in their own interest.
—The author, S Murlidharan, is a Chartered Accountant and columnist. The views expressed are personal.
(Edited by : C H Unnikrishnan)
First Published: Feb 22, 2024 8:56 AM IST
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