Indian firms moving away from ESOPs

Options are still the most commonly used long-term incentives, but companies are turning to sharper performance-based alternatives.

Though stock options are the most commonly used long-term incentive (LTI) vehicle in India, there is an emerging trend of companies moving away from options"" which may strengthen"" according to the findings of a Mercer HR Consulting survey.

One driver of this is the recent mandatory expensing of options, which has levelled the playing field by making the true cost of stock options more transparent and allowed comparisons that create an expense on company financial statements.

Another factor influencing use of alternate vehicles is the perception of 'value' in the eye of the employee, says Mercer. Vehicles such as restricted stock units granted at a heavily discounted price (RSUs or the right to receive shares after certain restrictions lapse, and employees receives whole shares, and pay a minimal price or no price for the purchase, and the restrictions can be service- or performance-based), have a far stronger retentive effect, and a greater perceived value among employees.

The impact such factors have begun to have on LTIs used by companies is illustrated by the fact that in recent years Infosys Technologies suspended its ESOPs scheme and went back to rewarding their employees in cash, also announcing a deferred compensation scheme for its senior management.

Wipro has also moved away from ESOPs and now uses RSUs as its preferred LTI, as do Satyam Computers, Novartis and i-gate.

Hindustan Lever recently introduced a performance share plan in line with global Unilever norms (the right to receive shares is linked to the achievement of certain performance objectives at a company level, and the number of shares earned depends on performance).

Some of the participants in the Mercer survey, who are currently using options, said they were evaluating alternate LTI vehicles.

However, according to Mercer, given the performance of the stock market in India, the scale of wealth creation for employees that has been witnessed as well as concerns from institutional investors about grant of full value shares, options are likely to continue as the predominant vehicle in the near term.

Most of the companies surveyed by Mercer granted between 0.1 per cent and 0.9 per cent of their total paid-up capital in the most recent year as LTI to employees.

The highest 'burn rates' (an annual 'dilution' measure defined as total number of options or shares granted in the year as a percentage of total shares outstanding) in 2006 were among financial services players surveyed. Most companies surveyed appear to have lowered burn rates in the last three years.

Among the companies surveyed, overall participation levels, ie., employees given grants under the plan, ranged between 5 per cent and 35 per cent of employees in most cases. In a few cases companies were covering a much larger number-as much as 75 per cent of employees.

Typical participation levels were estimated at 100 per cent for top management (CEOs and direct reports), 75-100 per cent for senior management, 40-60 per cent for middle management and 0-15 per cent for junior management.

Retention of senior talent being a key objective, about 20 to 30 per cent of grants appear to be allocated to these levels among the companies surveyed. Around 60 per cent of the options were allocated to middle management, as they were considered important to nurture as the future leadership pipeline.

Very few companies covered junior levels, because they have seen that junior staff prefers cash in hand to long-term incentives. The large numbers of employee at this level also makes coverage difficult.

Most companies surveyed did not have a clearly stated 'target' LTI value as a percentage of total compensation (grant sizes are usually linked to grade and performance levels, and not to individual compensation).