ESOPs: Boon or bane

It has always been believed that motivated employees are critical for the success of a company. Employee stock option plans or ESOPs have been long considered globally as an important tool to align the interests of shareholders and employees, thereby motivating employees to work hard for value addition to the company.

Simply put, a stock option is, as the name suggests, an option but not an obligation to an employee to buy shares of his or her company at a predetermined price (exercise price). Thus, if the share price exceeds the exercise price, the employee gains, but if it falls below the exercise price, there will be no loss to the employee since the latter is not “obliged” to buy the stock at that higher price and can simply let the option lapse. It sounds extremely attractive for the employees with gains if the share price goes up but without any risk associated generally while dealing with any share. As a result, for long, ESOPs have been granted to employees as a long-term incentive plan (LTIP) and hailed as a great tool for “wealth creation” for an employee in tandem with shareholders. In the process, since vesting of such options (i.e. time when such options can be exercised) is over the next few years from grant, ESOPs have acted as an effective retention tool for good talent.

ESOPs have worked very well when the share price of a company went up steadily (or sharply), and acted as a great motivation tool as they were intended to. However, as markets become more volatile with share prices of companies becoming uncertain, over time ESOPs have been seen as acting in an opposite direction than planned and, in many cases, have become a source of demotivation, heartburn and caused employees at times to act against the best interests of the company.

Let me explain. It is today common knowledge that in almost every company where employees have been granted ESOPs, the employees watch the share price movement more closely than even the promoters of the company. It is also a common fact that in companies whose share price underperforms vis-à-vis its anticipated future price at the time of grant (with consequent anticipated profits to the employee), the discontent among the employees is huge. In fact, most of them feel that they have been “cheated” of what should have been their legitimate “long-term incentive” for being with the company. As a result, the HR departments in such companies are flooded with demands for cash compensation in lieu of such “defunct ESOPs”. In many instances, managements have been forced to agree to such demands to restore “motivation and retention”.

Another adverse aspect witnessed due to ESOPs is that the employees (including, at times, senior management) start focusing so much on share price that their business decisions start getting decided by an assessment of “what would increase the share price” and vice versa. The consequence is that actions and strategies that would be in the long-term interest of the company, but which may adversely affect the share price in the short to medium term, get compromised. A case in point could be a good acquisition that would be strategically important for the company, but which could result in dilution for existing shareholders and/or increase in debt. It is well known that in case of such acquisitions generally the share price of the company takes a beating temporarily.

This indeed is a very dangerous trend that is rapidly emerging in the corporate world. Today, it is common knowledge that the “morale” of the employees in many companies with ESOPs these days is directly linked to the share price of the company and thus fluctuates virtually on a daily/weekly basis.

I feel it is time to go back to the age-old proven management principle that incentives for employees must solely be linked to such performance indicators that are beneficial for the business. Share price as an indicator of performance of a company is certainly not one of them because it may not have linkage to the actual performance of the company and could (in fact, many times in real life) depend on extraneous factors, which are unrelated to the company. Wars, climate related mishaps, inflation, terrorist activities, geopolitical developments and political changes are some such factors.

Accordingly, I strongly feel that a better way of giving long-term incentive is deferred cash over the years, purely linked to key company and person related performance parameters — both financial and non-financial. This would ensure that the employees concentrate on the work assigned to them for the betterment of the company and not the share price ticker on the TV screen.

The writer is vice-chairman, Bharti Enterprises