Employee Stock Option Plans, popularly known as ESOPs, is a concept introduced in India. It is used by companies as a scheme of selling shares to the employees by which they become a shareholder in the company and thus hold a certain small level in the ownership of the company.

ESOPs are given by the companies to the employees thereby, giving them the following rights:

  • Right to purchase a certain number of shares in the company-at a pre-determined price after a predetermined period.
  • It helps the employer to retain the company and assure a good level of performance in the work.

ESOPs serving a 2-fold purpose for both the company & the employee

ESOPs are generally awarded for performance or tenure of the employee with the company thus, it serves a two-fold purpose for both the company and the employees.

  1. It acts as a tool of motivation for the employeesfor a basic reason that once they own a stock they feel responsible for performance of the company, as it determines the value of the stocks of the company. If the company performs well, the value of the stocks rises and vice-versa.
  2. It helps the employer to retain the company and assure a good level of performance in the work.

Employee stock option plans serving as a motivational tool for employees

These ESOPs are offered by the companies in parts and as per a schedule.

For instance, today an employee might get 4000 shares given in sets of 1000 or 500 shares over a period of time. A time period is given to the employee for exercising their right to purchase the shares. This time period of waiting is called a vesting period. The offer lapses if not exercised within the vesting period. This period is also known as the lock-in period.

Who Are Using ESOPs?

The scheme is mostly used by IT companies who were actually the first one to jump into the bandwagon when the concept was introduced in India. But now, other sectors including the core sectors, such as steel have realized the potential that ESOPs hold.

As per a survey,

  • While around 43% of the IT companies have given ESOPs to more than 90% of the employees, only 17% of the Non-IT companies have done so.
  • More than 75% of the Non-IT companies offer ESOPs only to the senior and middle management employees.

As per this survey of 2001, it is however revealed that-

Within the IT companies, while only 23% of the large companies offer ESOPs to more than 90% of the employees, the number is as high as 60% in case of smaller companies.

  • A significant 54% of the large IT companies offer ESOPs to less than 25% of their employees.

Advantages of ESOPs

ESOPs provide advantages like:

  • Aligning the interest of the managers with those of the owners.
  • It is a non-cash compensation tool to compete for the best human resources.
  • It gives an opportunity to corporate to pay without a reduction in book profits [ accounting advantage].
  • Sense of Ownership and Belongingness amongst the Employees.
  • Lower Attrition Rates.
  • Boosted Morale of Employees.
  • Greater Effort on the Part of Employees.
  • More Equitable Distribution of Profits.

Basic Features and Types of ESOPs

The conventional stock option plans give the employees a choice or option to a fixed proportion of shares in the company or their employer.

However, it must be understood that- the employees are under no obligation to buy these fixed number of shares and they are free to reject the offer if they wish to.

These offers vest over a period to an employee subject to fulfillment of certain conditions such as-

  • continued employment for a specified period or
  • there can be performance based plans wherein the employee has to meet certain level of performance as laid down by the Company.

When it comes to classifying the ESOPs, it can be divided under two categories, namely:

  • Non-Compensatory Plan
  • Compensatory Plan

Non-Compensatory Plan

It is the one under which the employees do not get compensation. The basic purpose of such plan is to either diversify ownership to include the employees or to raise additional capital for the Company.

Under a non-compensatory plan the shares can be in future at the market price on the date of exercise/vesting.

Compensatory Plan

Under this category, the employees are compensated. In other words, services rendered by the employees are partially compensated for the issuance of shares of a certain value.

Companies use these kind of plans to motivate the employees. Compensatory plans are particularly useful for the fast growing knowledge-based companies that usually do not pay large salaries to the employees.

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