I have often been intrigued by disclosures about employee stock option plans (Esops) of the companies that I am invested in. How many shares are the companies giving out? Who are they giving to? What is the criteria?
I chose to look at it from the perspective of a long-term shareholder. I want to be sure the company is attracting and retaining the best talent out there, while at the same time being fair in its practices and approach to rewarding employees.
I looked at publicly available Esop policies of two companies that I own shares in. Here’s Infosys’s criteria as per its 2019 release: The grants allocated to employees over a period of seven years will vest based on challenging performance criteria of a) relative total shareholder return (TSR) against an industry peer group, b) relative TSR against domestic and global indices and c) operating lead performance metrics such as total revenue and digital revenue growth, and operating margins. Additionally, the total grant has been specified as 50 million shares, or 1.15%, of the company. The terms are clear and designed extremely well, aligning benefits to the interest of the other stakeholders i.e. the company and long-term shareholders.
Now, here’s an extract from the other company, which I will refrain from naming: Esops may be awarded to ensure a long-term commitment and prudent decision-making aligning employee’s interests with the shareholder’s interests. A deeper dig revealed the vesting period to be three years. Perhaps they have other guidelines, but not available in the public domain.
This left me anxious. On the one hand, one of my investee companies has a transparent policy that’s designed to keep everyone’s interests aligned, on the other hand, it’s not clear whether the second even has some policy.
Esops are important for various reasons. The most obvious is to attract and retain talent. If done well, this is a small cost to pay for potentially large long-term gains for other stakeholders. This is a big “if” here. Recently, it came to light that the chairperson of a company owned Esops valued at ₹480 crore in the same company. Whether that is legally right or not, to me, this does not reflect a high level of corporate governance. If it was, all this information would have been public right from get go. There is one other reason I am interested in this. Esops are earnings dilutive. For the same amount of earnings if there are more shares, then you get a lower earnings per share. And therefore, if Esops, which amount to issuing new shares, are not handled well, the “loss” to some stakeholders just compounds.
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Take for instance a company that regularly gives out 1% of new shares as Esops every year. By the end of the 10th year, it would have given 10.5% of the company away, which, if not done well, is a hit to the earnings per share. A good policy would make up for this dilution in terms of having the best talent, which would reflect in higher profitability. Given that price is a multiple of earnings per share and a valuation multiple, the loss in total value of the company is a multiple of that. It can be potentially very significant.
Now, of course, I am making some assumptions. The Esops are not free, they are paid for. But for a company that does not need to raise capital, the dilution needs to be very well justified. Some may be thinking about the company buying shares from the market and giving them. This, while not being dilutive, still impacts the company as the cash paid out could have earned interest income or been paid out as dividends. So, there’s a cost there too. The exception to this rule is perhaps where the promoter/founder gives away their shares as a benefit.
Coming back to the question – Should companies make their detailed Esop grant criteria public? Yes; to open their policies for investor scrutiny. We already know how much companies give out, and to who all (at least the key employees; available on the stock exchange website). It’s perhaps time to understand why they gave it in the first place (at a broader level, not individual level).
Meanwhile, this is just one other instance where some elements of improvement remain. I must add here that Sebi has a policy on Esops in place, but that’s more from an administrative and regulatory perspective. The key parts of why, when, and how much Esops to give is ultimately in the hands of the company.
(For an extended version of this column, log in to livemint.com)
Rahul Goel is the former CEO of Equitymaster.
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Published: 26 Dec 2023, 12:45 AM IST