ESOPs have traditionally been used by companies to enable employees to participate in the growth journey of the organisation. However, with close to a third of the world population being in complete or partial lockdown and the world economic activity brought down to a screeching halt, growth has taken a back seat. The biggest challenge for companies right now is to ensure business continuity. And this is true for all businesses, irrespective of their stage of growth.
In a bid to stay afloat, companies across the world have undertaken (or are contemplating) a number of measures, right from deferring bonuses, reducing salaries, putting employees on furlough to even laying off employees as a last resort. The current environment, coupled with the strong measures that businesses are being forced to take, does not create a conducive environment for the retained employees to function properly or make an active contribution to the Company at this crucial time.
It is times like these when employees look up to their leadership to act in their best interests. How the companies and its leaders handle the current situation will have a huge bearing on the employee morale and go a long way in instilling either a sense of belonging within the employees or the lack of it. We believe that times like these call for empowering employees more than ever and bringing them together to participate in the sustenance and recovery of the company. Looking for innovative ways of optimising costs is therefore the need of the hour for every founder, CEO and investor.
As such, ESOPs can be a great tool for companies even in the current scenario. Used rightly, ESOPs can not only empower the employees to be partners in the recovery of the organization, thereby boasting employee morale, but also help companies in conserving immediate cash outlays.
In this article, we share why ESOPs (and other share-based payment instruments such as RSUs) should be even more at the forefront of corporate compensation and retention strategies in the current times.
Needless to say, cash is the most valuable asset on any company’s balance sheet in this environment. As part of finding ways and means of conserving cash, companies are reassessing their compensation structures and putting in place various immediate and short-term measures to achieve this. These include measures such as deferring / slashing bonuses, asking employees to take temporary voluntary pay cuts or utilize their paid leave balance during this period.
We believe as companies revisit their compensation structures, they could benefit by replacing the variable compensation (or even a portion of fixed compensation, if needed) by offering employees equivalent or enhanced amount of ESOPs (or other customised share-based payment instruments). This effectively offers employees the potential to earn much higher gains in the long term in lieu of the reduced current compensation. In addition, it sends a (much needed) positive message to the employees that their efforts over the past year have not been completely wiped off and instead will be rewarded by a higher amount once the situation stabilizes. One start-up has already gone down this route and implemented a scheme of voluntary reduction in salary by employees being replaced by issuing ESOPs Refer link for more details:
Further, companies may look to increase the overall contribution of such equity settled instruments in their compensation structure. This can be an effective tool to conserve cash in the current environment as ESOPs (and other equity settled instruments) only result in a notional charge on the Company’s financials. Any such adjustment to the compensation structure should be done considering different aspects specific to the organization and considering the requirements of employees at different grades.
The current crisis has all companies, irrespective of their scale, grappling with same questions and challenges. Most mature / listed companies have experienced a significant drop in their share prices, setting it back to the levels observed, say, 3 to 4 years ago.
For instance, we looked at the share price movements for 4 listed companies selected at random (Maruti Suzuki, Hindalco Industries, Tech Mahindra and Page Industries) between April 2015 to April 2020 to assess the number of years by which the shareholder’s wealth had gone back by. The analysis demonstrated that the share price for Maruti Suzuki and Hindalco Industries had been set back by c. 3 to 4 years whilst that of Tech Mahindra and Page Industries had been set back by c. 2 to 3 years. The same is evident from the graph below which shows the share price movement of these companies over the chosen period. For ease of comparison, the starting share price has been rebased to INR 100 for all companies and the movement thereafter determined by replicating the movement in original share price.
Majority of such organizations already have active share-based payment plans in place. The same can be leveraged to:
a) compensate employees on a broad-based level by allowing them to buy shares in future at the current market levels against any immediate measures that companies may have to undertake; and
b) award Performance shares / Restricted Stock Units to senior management of the Company tasked with specific objectives as part of the COVID-19 strategy. Under these, the shares are given to employees at zero price or at face value provided they meet the performance requirements laid down by the Company.
Thus, these companies can effectively reward employees for bringing back the Company to pre-COVID levels of growth and profitability.
In this context, we also note that during 2008-09 Global Financial Crisis, many listed companies adopted similar strategy and continued issuing one or more forms of these plans as an active part of the compensation strategy. In-fact, many players which have previously reduced the number of stock options grants, increased the quantum of same in 2009 in a bid to retain talent and contain the cost. Many players also started issuing ESOPs for the first time in 2009.
Refer link for more details:
Every business may have to make some tough decisions at this time. However, there may be merit in letting employees participate in such decision making rather than taking the decision singlehandedly. Again, we believe share based payment schemes are a great tool in such recovery plans for the Companies as they effectively bring in a sense of ownership in the employees, which in turn urges them to act in the best interest of the organization (just like a shareholder would) rather than act for individual goals alone. Such an approach may mean that employees may willingly accept measures which impact everyone proportionately rather than instituting measures which impact a few individuals disproportionately.
The specifics of how such recovery plans and hence the corresponding share-based schemes are structured will vary for each company, depending upon the extent of financial impact on the organizations and the unique challenges it may face. However, putting in such a strategy may yield a positive employee attitude at this crucial time and also enforce a sense of belonging within the employees.
Some companies may also find themselves in a situation wherein the ESOPs issued by them in the past may now be ‘under-water’ or ‘out of money’ i.e. options where the exercise price is higher than the current market price of shares of the Company.
If your organisation in facing such a situation, the management should actively reach out to the employees and acknowledge that they are cognizant of this issue and that appropriate action would be taken in due course to ensure that employees options are again ‘in-the money’. Once the situation stabilizes to some extent, the management must assess such options and take a call on either repricing these scheme (if necessary) or cancelling old options and issuing new ones. Of course, there may be cases where companies may believe that the issue of under-water options is only short lived and that the Company would soon be back to its pre-Covid levels, in which case, the employees should be appraised of the same.
Note that before taking any action on either re-pricing or cancelling old options and replacing with new ones, the Companies must weigh the following:
a) accounting implication of a modification vis-à-vis cancellation of options – Accounting norms may mean that the Companies may have to recognize full charge on old scheme before repricing / cancelling, depending upon the specifics of the case.
b) Impact on employees of the action taken. For example, cancelling the options and replacing the new ones may mean extended vesting period for employees which may not be advisable at this time.
As the world grapples with the effects of COVID-19, all entrepreneurs are faced with a tough task of sailing their organization through this time. How they steer their Company will make all the difference and really define what their Company stands for. They say that the best companies and entrepreneurs thrive in hard times and use constraints to drive innovation and growth. This pandemic with its multi-fold effects is definitely one such time, testing us all and yet giving us a chance to reset.
From a workforce perspective, this is time to re-evaluate how we compensate the employees as we all are faced with tough decisions on managing cash-flows and ensuring business continuity. Its more important than ever to be innovative in how we achieve this and look for alternatives to lay-offs and salary cuts without any corresponding compensation. We believe ESOPs and other share-based payment forms can be one of the many arrows in the Company’s armoury, whereby you ensure that your employees receive an equity as part of their compensation, so that they’re not just having to live paycheck to paycheck, but also have something that appreciates in value!
Should you have any comments or thoughts or feedback, please feel free to share write to us. We would love to hear from you!
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