Why do companies reward employees with sweat equity?

Why do companies reward employees with sweat equity?
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First Published: Mon, Jul 23 2007. 01 04 AM IST
Updated: Mon, Jul 23 2007. 01 04 AM IST
Our friend Johnny is disturbed. He is disturbed because strange terms—Esops, sweat equity—keep echoing in his head, and he is not able to understand their meaning. As usual, the only hope for Johnny is to talk with Jinny and clear his doubts.
Johnny: Hi Jinny! I hope today too you will clear all my doubts.
Jinny: Why do you want to clear your doubts? Don’t you know doubts and dandruff are signs of a fertile head? Did you notice that bald people have no dandruff?
Johnny: But bald people can have doubts. Anyway, I never intended to start a discussion on dandruff. I hope you will not mind if I ask you about Esops or sweat equity shares. Can you provide me some insight on these terms?
Jinny: Providing insights on Esops or sweat equity shares may not be as interesting as starting a discussion on dandruff. But I will do my best. Let’s start with the basics. As you may be aware, the term Esops stands for employee stock option plans. Many people think that the term Esops sounds like the name of a bug. So they use sweat equity as another respectable name for Esops. However, some experts may draw a finer line of distinction between the two terms. Let’s not get into that to keep our discussion simple. Many firms allot sweat equity shares to their employees as a reward for sweating on their jobs. But please don’t think that you can also earn sweat equity shares by literally sweating in your office. The funda is fairly simple. Suppose I contribute money for starting a firm and you contribute your expertise and labour. Both money and expertise are equally important for the success of the firm. Keeping your value-addition in mind, I may give you an option to acquire the shares of the company. This allotment can be either free of cost or at a concession depending on how much I want to reward you.
Johnny: It means that sweating in the office really pays. But I used to think that sweating only gives you a salary that you carry home at the end of the month. Why do companies reward employees with sweat equity shares in addition to whatever salary they are already getting for doing their job?
Jinny: Esops are not like the monthly salary. They are more like dangling carrots to make employees stay with the company. Esops give you an option to acquire the shares that can only be exercised after a fixed period. As per Securities and Exchange Board of India (Sebi) guidelines, there shall be a minimum period of one year between the grant of options and vesting of options. Vesting of an option entitles you to actually apply for the shares offered. In case of resignation or termination of the employee, all options not vested lapse and the employee can claim no benefit.
This ensures that you continue to work for the betterment of the company. Sebi guidelines further provide that the company shall have the freedom to specify the lock-in period for the shares issued pursuant to exercise of option. So even after acquisition, the shares may continue to have a lock-in period so that you can’t immediately sell them in the market.
Johnny: Oh I see! Esops are like golden chains, which the companies use to hook their best performing employees. But tell me, how can you ensure that Esops are not misused to the detriment of the equity shareholders of the company?
Jinny: There are numerous checks to ensure that Esops are not misused. In the first place, Esops can be issued only with the approval of the shareholders through a special resolution in a general meeting. Second, all terms and conditions on which Esops are issued are determined by the compensation committee of the board of directors, which has a majority of independent directors. Further, an employee who is a promoter or belongs to the promoter group shall not be eligible to participate in Esops. A director who either by himself or through his relative or through any body corporate directly or indirectly holds more than 10% of equity shares in the company is also not eligible to participate in Esops.
These safeguards ensure that people having control over the company do not misuse Esops for acquiring shares at a dirt-cheap price.
Johnny: So many checks and balances. I think you have given me enough idea to start having a new doubt. This shows that I have a fertile head. Anyway, I just hope that Esops will continue to prosper for the benefit of those employees who sweat day and night for their companies. See you again. Bye.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to them at realsimple@livemint.com
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First Published: Mon, Jul 23 2007. 01 04 AM IST