Concept
Employee Stock Ownership Plan (ESOP) is a form of corporate financing where company’s employees are offered ownership interest in the company. This is an employee benefit and deferred compensation plan with very favorable features. Almost all industries, mainly IT, in India and overseas use this plan aiming at company’s and workers’ benefits.
In this type of plan, the workers of a company are offered company’s shares, usually free of cost as a part of their total remuneration. These shares are maintained in a trust and are given to the employee when he leaves the company. The company then buybacks the shares at the current market price or the employee holds them to sell in the public market. The employee gains from the value appreciation of the shares.
Corporations adopting this type of employee stock ownership plan are called Employee-owned Corporations. However, unlike worker cooperatives, executives of these corporations retain more ownership and management control. Corporations adopt means to limit the stock holding of a common employee in order to avoid chances of a takeover.
Rationale
- Departing owners of privately traded companies get a ready market to sell their shares.
- ESOP can borrow money at a very low tax deductible cost.
- This is a good method to retain and reward valuable employees of the company.
- Companies with low cash flow use this plan to avoid cash compensation to the workers.
Pros
- ESOPs motivate the employees to work for company’s better performance. Plan participants are workers as well as shareholders of the company. Understandably, their gains and losses depend on company’s good or bad performance respectively.
- It is like a qualified pension plan and employees need not pay taxes until they receive benefits from this plan. The sponsoring company is also entitled to various tax benefits.
- Employees’ savings are in terms of shares from ESOP and these often generate higher value than mere cash.
- Employees get voting rights.
Cons
- Employees’ retirement savings get concentrated in a single company. This enhances risk as employees’ portfolio lacks diversification.
- Studies show that only the benefit plans are not enough for increasing workers’ productivity. There should also be means for empowering the workers.
- This type of plans discriminates between old and new employees leaving only a limited number of shares for the later group.
- Costs associated with setting up and administrating this plan are excessive.
- If the company issues new shares, the stock of plan participants gets diluted.
Indian Scenario
Since 1995, Income Tax Authorities are imposing taxes on plan benefits. The capital gain tax applies to all the companies whether they are listed on Indian market or outside.
Following SEBI’s guidelines, an employee is entitled to such benefits only if he/she is a permanent employee of the Indian company irrespective of his country of residence. Even a full-time director can participate in this plan.
Indian companies now understand the importance of intellectual capital and therefore, they are in favor of ESOP. However, it is still not popular as a means to raise fund for companies operations and expansions.
