Why stock options are losing sheen

Radhika Merwin BL Research Bureau | Updated on August 12, 2014 Published on August 11, 2014


No broadbased ESOPs; handed out only to top management

Over the last two decades, many of the junior staff who worked with Infosys in its initial years turned multi-millionaires, thanks to its liberal employee stock option plan (ESOP). With start-ups such as Flipkart and Snapdeal now seeing their valuations soar, can we expect a new wave of ESOP millionaires?

Only for the seniors

Not really, say compensation experts. For one, companies today are no longer handing out stock options to all employees but restricting them to senior management. According to the Equity Compensation Trends Survey 2014, conducted by ESOP Direct, 69 per cent of total stock allocations today are made to senior management — the CEO, the CXOs and those who report directly or indirectly to them.

“Indian companies are giving stock options to employees who drive revenues and growth. They are not using it as a broad-based instrument where every employee is given an option. Yes, a long time ago, Infosys did offer broad-based stock options, but it realised that it would not be able to continue the practice,” says Harshu Ghate, Co-Founder and CEO, ESOP Direct, which advises companies on equity-based compensation.

No discounts

Two, even to the select employees, stock options are no longer offered at a throwaway price (such as the face value of the share). Earlier, options could be exercised (exchanged for shares) at steep discounts to the stock’s market price, helping the employee pocket a neat gain from the difference. But companies have changed their policies over the last couple of years, as investors felt short-changed when shares were issued to employees at deep discounts, resulting in dilution of the equity base.

Data for 101 companies tracked by ESOP Direct showed that 72 per cent of the listed companies issued options at market price, while only 7 per cent did so at face value. Among unlisted companies, 50 per cent granted options at an estimated fair value and only 25 per cent at face value.

Uncertain exits

The third reason why the allure of stock options has faded is that exit routes available to employees have not been well-defined, particularly for the fast-growing unlisted companies.

“Many employees are not aware that unless shares are listed, there are serious limitations on liquidating the shares and making money. The real liquidity happens only when shares are listed,” says Ghate

The recent controversy over employee stock options at redBus underlined this problem. According to reports, employees lost out on the opportunity to cash in on their ESOPs when the firm was sold to the ibibo group. The options did not have a clause allowing employees to exercise them before their maturity date, even if the company was sold.

For employees in unlisted firms to really benefit from ESOPs, “it is essential that the company define all the possible exit options. If IPO is the only exit route offered, it should be mentioned clearly. Lack of such awareness leads to a feeling of resentment” says Ghate.

According to ESOP Direct, 62 per cent of the companies have a clause in their ESOP Scheme which says employees will be able to exercise their options only after a liquidity event, such as an IPO, buyback or strategic sale.

Published on August 11, 2014
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