Employee stock lolly turns bitter - Crash erodes Esop value

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  • Published 27.10.08

Calcutta, Oct. 26: Stock options issued by several companies have been shredded into worthless bits of paper in the ferocious market meltdown.

The volatile market has left employees holding grants that were issued more than three years ago from which they can no longer derive any benefits.

“The market meltdown has led to a situation where the employee stock option plans (Esops) will provide no real benefit to employees,” said a senior official with Deloitte & Touche Consulting.

Result: there is a strong possibility that employees will now start spurning stock option offers, preferring instead to be compensated in cash.

In one sense, this is a throwback to 1998 when employees of many companies — though not frontline infotech companies — found they had no use for stock options and preferred fatter pay packets. Stock options caught on again after a four-year hiatus, long after the dust from the dotcom bust had settled.

But with the sensex plunging by over 45 per cent in this calendar year, stock options no longer enjoy the price discounts they did during the stock boom since 2005.

Take an example: employees at Infosys were able to exercise their options at an average weighted price of Rs 634 last year under its Stock Option Plan of 1999, according to the company’s annual report.

The weighted average price on the 15 lakh options that are still outstanding has swelled to Rs 1,163, which is just a tad lower than last Friday’s closing price of Rs 1248.75 on the Bombay Stock Exchange. That is one of the main reasons why none of the employees has exercised the option in this fiscal.

Companies tend to grant stock options in driblets throughout the year and rarely, if ever, give it at one go. Since the pre-determined option price is calculated on the basis of a formula linked to the ruling market price at the time of the grant and the expected volatility in the stock, options are variously priced. For instance, Wipro issued stock options in 144 tranches over a three –year period, according to data sourced from the Centre for Monitoring Indian Economy (CMIE). Satyam Computers had 143 tranches.

The Infosys employees still have a price headroom on their options; others have not been so lucky.

The stock option — one of the best deferred benefit programmes that India Inc has used to retain managerial talent — arrived on the scene in the early nineties and has gone through several refinements since.

In the initial years, it was used primarily by infotech giants — Wipro and Infosys — to ensure rivals didn’t poach their top talent.

Later, a number of other companies like ITC, ICICI Bank and even Bajaj Hindustan Sugar and Industries latched on to the concept as they fought to keep their best managers.

Two developments changed the rules of the game for stock options: the first was a set of guidelines issued in 1999 by the capital market regulator which tightened option pricing rules; the second was the imposition of a fringe benefit tax (FBT) through the Finance Act 2007 which is applicable at the time of vesting rather than when the option is exercised. Companies typically pay FBT and later recover it from employees.

The imposition of the FBT wasn’t bad as long as employees made gains when they pressed the button to convert the options into shares. There has to be a minimum period of one year between the grant of the option and vesting — a process under which the employee earns the right to apply for the shares.

But now a piquant situation has arisen: employees have already paid the FBT but are unable to exercise their options because of the market meltdown.

Does this mean the end of the road for stock options?

Rachna Nath, executive director (performance improvement) at PriceWaterhouseCoopers, doesn’t think so. She believes that Esops will still be a favoured compensation option. “But this will depend on the health of the individual company and the industrial sector it belongs to,” she added.

Nath reckons that stock options will be out of favour in the financial services industry, but manufacturing companies will still be able to use them to retain talent.

Companies can, of course, re-price the lapsed stock options after seeking shareholders’ approval. The Deloitte official believes that several companies will do so.

But in an uncertain and volatile market, employees may not bite the bait.