How to encourage employee ownership

How to encourage employee ownership
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First Published: Fri, Jul 31 2009. 11 53 PM IST

Under ESPS, direct shares are issued to employees with a minimum one-year lock-in. Ahmed Raza Khan / Mint
Under ESPS, direct shares are issued to employees with a minimum one-year lock-in. Ahmed Raza Khan / Mint
Updated: Fri, Jul 31 2009. 11 53 PM IST
Recent Budget proposals by finance minister Pranab Mukherjee included a requirement for listed companies to have public shareholding of at least 25%. The current threshold is 10%. Several of the listed companies, including most of the public sector units (PSUs) and state-owned enterprises would fall short of the 25% level.
Public offer of the existing shares by the promoters (or the government in case of PSUs) or of fresh shares by the firm appear to be the most talked about options to achieve the target public holding. However, the route that needs a close look is broad-based employee ownership. Each of these routes (see chart 1) has varying impacts for a firm as well as its promoters in terms of cash flow, cost of execution, taxation, equity base and so on. Priorities and situations may be different for different stakeholders so a single solution will not suit all.
Under ESPS, direct shares are issued to employees with a minimum one-year lock-in. Ahmed Raza Khan / Mint
Each of the routes (see chart 2) comes with its own pros and cons. If one were to focus on company impact alone, route 1 and 2 look least attractive. Among 3, 4 and 5, route 4 seems more viable than others. It has zero cost of execution, no change in equity base and outflow in funding is in the form of a loan, which will be recovered over a period through dividend earned by the trust and as and when employees exercise their options. Between 3 and 5, route 5 has zero cost of execution and the neutral cash flow will turn positive as and when the trust repays the funding. For firms not wanting to increase their equity base, route 4 is the best fit.
Depending on the gap to be filled in, a combination of more than one of these routes will have to be looked at. For instance, if the current public holding is 10%, the gap of 15% could be met with a combination of routes 3, 4 and 5. However, if the gap is 5% or less, preferential allotment (route 3) may not be viable and the Esop route (routes 4 and 5) could be evaluated.
Apart from the parameters evaluated above, Esop routes should be preferred to achieve other objectives such as:
• Wealth sharing with employees
• Broad-based employee ownership to help synchronize with shareholder goals
• PSUs could use this to allay employee fears of privatization by making them part of the process
• Rather than diluting to a single institutional investor, it may make more sense to have dispersed shareholding among employees rather than general public
• Public float under Esop routes will increase gradually as against a preferential offer. This will help in minimizing the negative impact on share price
• Preferential allotment could come with some other constraints such as board representation, restriction on promoter share transfers, other operational covenants. Esops would have no such constraints or impact on the company management and operations
Within the routes, firms could use a mix of employee share purchase schemes (ESPS) and employee stock options (Esops).
Under ESPS, direct shares are issued to employees with a minimum one-year lock-in. These shares could be issued at market price or even at a discount, based on shareholder approval. The cash flow for the firm would also be immediate in case of ESPS, where employees have to purchase the shares upfront. Globally, ESPS is the most popular route firms take to encourage broad-based employee ownership. Every employee of the firm is entitled to participate in these plans with an upper limit. In the given context, where employee retention and performance related pay are not the key considerations, ESPS that lead to wider public holding would be the more appropriate instrument to use.
In case of Esop plans, it would be advisable to set up a trust to administer the plan. Shares could be issued upfront to the trust, which in turn can transfer it to employees as and when they exercise options over the exercise period. Shares held by the trust will qualify as public holding. Upfront issue to the trust will ensure adherence to the 25% level at an early date.
Harshu Ghate is co-founder and MD of ESOP Direct.
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First Published: Fri, Jul 31 2009. 11 53 PM IST