ESOP’s re-pricing

ESOP’s (Employee Stock Option Plans) have always been issued as an incentive to retain good employees. In times of rising markets employees gain along with investors hence investors have no grounds for complain for issuing a small percentage of shares as per the approved plan to employees at the price determined as per SEBI’s pricing formula. The price so determined is usually much less than the market price in times of rising stock markets which is inherently beneficial to the employees.

The question to be addressed is whether ESOP’s should be re-priced in normal and abnormal scenarios. By normal scenario, I mean in cases where the markets are fairly priced, but a particular company’s price has fallen drastically. This by implication would mean that the company has not performed to expectations. The fact that a company is not doing well economically would imply that the employees are not performing or the management team is not leading the company in a profitable direction. In either case should the ESOP’s be re-priced? That is the question. The revised SEBI guidelines would imply that employees can be rewarded for non-performance in such a situation. Internationally re-pricing is looked down upon as being unethical. ESOP’s is akin to performance bonus, in such situations, paying performance bonus is like rewarding an employee when he has not performed at all. Thus, it would appear to reward failure! In such a situation the entire ESOP scheme becomes meaningless as the employees know that they will get rewarded whether they perform or not! Thus employees will stand to benefit either way, if the market rises they gain anyways, and if the markets fall they still benefit because of the re-pricing of ESOPs.

The situation in an exceptional economic scenario as the world is facing today would be different. In the current global meltdown all company’s shares have taken a hit worldwide, whether they are performing or not. Thus ESOP’s given at the peak of market conditions are not sustainable at all and would probably not be worth the paper they are written on today. In this case a re-pricing strategy would make more sense rather than an umbrella guideline which allows re-pricing. It would be advisable to modify the Guidelines on ESOP’s to permit re-pricing only in the case of exceptional economic circumstances which can be notified by the Government considering various national/global economic indicators.

Employees being economic value creators as far as the company is considered, gain by getting ESOP’s which like mentioned earlier is akin to a performance bonus. Similarly investors are rewarded when the employees/company’s performance is rewarded by the market by taking the price up. In such a scenario both investors and employees are rewarded. But what happens in bad economic conditions? The employees are rewarded and the investors lose out as they have no such recourse to cash in. This would be patently unfair and SEBI should have a re-look at the guidelines. Another issue is that the original ESOP scheme requires a special resolution (75%) of the shareholders for approval and strangely for re-pricing only an ordinary resolution would suffice. I think there is definitely something remiss here and SEBI would need to re-examine the guidelines more rationally. It may be election time, but there is no need to do things without thinking.