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The Esops fable comes to an end

R Raghavendra in Bangalore | March 17, 2004

Employee stock options (Esops), which were once seen as the dream boat to millionairedom, is falling out of favour among employees.

And companies are rethinking their strategies on this score as Esops have to be treated in their accounting books as an expenditure. Software major Wipro has, in fact, stopped offering options for close to four quarters.

Says Pratik Kumar, corporate vice-president, human resources, Wipro, "We do not feel inconvenienced in attracting or retaining talent without the Esops."

He added that global financial accounting authorities have virtually decided to expense options. "What remains to be seen is how options are to be valued. In this situation, virtually no company is treating option as business as usual. Most companies are adopting a wait and watch approach and some have started re-designing their option schemes. Earlier, Wipro options were offered to sections of new entrants and for performance."

The other Bangalore-based software superstar Infosys, too, had suspended the scheme in May 2003.

Kris Gopalakrishnan, COO and deputy MD, Infosys, says "The withdrawal of Esops is not new. It was suspended in May last year. We need to figure out how it is accounted for as we are listed in both India and the United States and the accounting methodology is quite different in both the countries."

Added an industry analyst: "Even after the market stabilised after the tech bubble burst and subsequent fall, tech stock prices have gone up only moderately. There is also great volatility.

Therefore, employees granted options tend to substantially discount them. This is causing companies to think that we are granting a benefit which is not having the full feel-good impact. Now that companies know that they have to expense the whole exercise, there is much re-thinking."

A leading tech company which recently carried out an internal survey among their employees found that they overwhelmingly opted in favour of cash. However, Esops seems to be one of the main tools for fast emerging software companies whose faith in them are deepening.

Said Phaneesh Murthy, CEO of iGate Global Solutions: "Esops depend completely on the price expectation of the shares. Companies which have crossed or reached their peak capitalisation will find little or no takers for their stock by way of Esops. On the other hand employees do want to participate in the growth of their companies and would like stock as long as they can create value out of it. So I don't believe that this is an industry trend but a company belief. Employees are keen to create a certain return for their work and they will accept a combination of stock and pay - what combination is dependent on their perception of where the stock will go."

Supporting this view, CFO of an upcoming software company said: "For us, stock options has been an excellent employee motivation factor. There is still a lot of interest among employees for ESOPs. If a company chooses to discontinue with its Esops, it simply speaks about its stock prices."

"Since some companies are listed in the US and the US GAAP accounting system does not have a viable means for expensing full cost for the stock options plan, there is uncertainty for them in going in for Esop. Microsoft discontinued its employee stock option plan long ago and decisions like these only indicate that their stock price is a de-motivating factor. In the long-term, companies that continue to witness the benefit of providing stock options to their employees, have no reason to discontinue this practice," he added.

Subash Menon, president and CEO of Subex Systems, a software company growing by leaps and bounds, says: "We have recently held two schemes as part of our Esop. Nearly 740,000 shares or about 7 per cent of the fully diluted stocks of the company went to the employees. I do not believe that employee stock option is in lieu of the salary. Esop is a long-term initiative to keep the employees interested and motivated."

"Salaries are a short-term phenomenon to satisfy the employees. The expensing part of Esop clearly overshadows the level of interest among employees towards Esops. Expensing Esops is a direct hit to a company's bottomline. In the long term, it is indeed a rewarding initiative for any organisation. As companies move towards a corporate governance culture, I feel that they will eventually go for Esops and will also look at expensing them," said Menon.

Putting things in a perspective, H V Harish, director at A F Ferguson said: "The primary objective of Esop was to apparently align the employee goals with that of the company's shareholders and ensure loyalty. Unfortunately theory does not work well in practice. The programs worked so long as the market prices were up, the moment they went down, employees had no downside except they lost the potential gains. An ideal Esop should reward employees when the company performance (increased shareholder value) is up and punish them or penalise them for non-performance (decreased shareholder value) which means it should become a share-purchase and not an option."

Highlighting the rationale of Esops, Krishnakumar Natarajan, MindTree's president & CEO, enterprise business, said: "While Esop has been viewed today as a part of the compensation the fundamental premise of creating sense of ownership among employees is strongly driven by Esop and hence in a competitive market where each person needs to function with entrepreneurial drive Esop will drive the right behaviours. Companies which have stopped Esops are not questioning the concept. Since the accounting treatment is not clear they have stopped the same temporarily."

"Sharing wealth and success is key in attracting and retaining the right talent. While Esops as a part of compensation has got legitimised during the days of dot-com boom the underlying principle of sharing success and wealth cannot be disputed and is not easy to replace. It is a fact that several managements have seen options as a way to generate quick personal wealth but a few black sheep cannot colour the whole issue. What will emerge is that there will be a strong link between wealth generated by management for stakeholders and the returns which will accrue to management and employees. Some companies like IBM have already started a concept of 'Premium prices options' and the employees gain from options only if they have improved share value at least by 20 per cent," said Natarajan.



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