stake holder theory

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INTRODUCTION

.4

CONCEPT OF

STAKEHOLDING.5

THE USES OF STAKEHOLDING

....7

THE IDENTIFICATION AND DEMANDS OF

STAKEHOLDERS....8

CLASSIFICATION OF

STAKEHOLDERS...9

ROLE OF EMPLOYEES ASSTAKEHOLDERS10

LEGAL STATUS OF EMPLOYEES AS

STAKEHOLDERS...10

EMPLOYEES PARTICIPATION

MECHANISM.11

BARRIERS OF EMPLOYEES TO PLAY A FULL ROLE IN

CG....12

METHODS TO ENSURE THE PROTECTION OF

EMPLOYEES.12

FACTORS AFFECTING THE CAPACITY AND MOTIVATION TO

REPORT....13

EMPLOYEES ROLE IN CORPORATE STRUCTURE OF DIFFERENT

COUNTRIES..15

UNITED

STATES......15

GERMANY

....15

UNITED

KINGDOM.16

INDIA

.16


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EMPLOYEES STOCK OPTION

PLAN...18

IMPORTANT

TERMS.......18

WAYS IN WHICH A COMPANY CAN SET UP AN

ESOP...19

DIFFERENT TYPES OF

ESOPS...20

SHAREHOLDERS APPROVAL FORESOP.............................21

RULES ANDREGULATIONS..21

CONCLUSION

.23

BIBLIOGRAPHY

.....24

INTRODUCTION

Good corporate governance helps to ensure that corporations take into

account the interests of a wide range of constituencies, as well as of the

communities within which they operate, and that their boards are accountable to

the company and the shareholders. This, in turn, helps to assure that

corporations operate for the benefit assures that corporations operate for the


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benefit of society as a whole.1

Different factors like transparency,

accountability, fairness, responsibility are the vital factors on which good

corporate governance is grounded. Giving importance for different stakeholders

is also another important facet of good corporate governance. Traditional view

is that primary aim of corporate governance is the shareholders profit

maximization alone. But in due course of time as the structure of the

corporation changed the management system, the relation between the

stakeholders has changed a lot. Moreover the theoretical conception about the

corporation itself has taken some other form. The evolution of stakeholder

theory can be considered as another important turning point in this field. The

purpose of this paper is to focus on employees as stakeholders in the corporate

governance structure.

1 Preface, OECD Principles of Corporate Governance (1999)


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CHAPTER 1

CONCEPT OF STAKEHOLDING

The theory of stakeholding in the corporate context posits that those whoparticipate in or are affected by the company as individuals and groups. All

merit consideration and involvement in its decision making they have a stake

in it. The quality of membership entails responsibilities on the part of all

involved as well as rights associated with belonging. A stakeholder philosophy

starts from the premise that inclusion social political and economic is a valuable

concept. The mutually responsive connections of persons in the social economic

and political systems, so it argued, better results for all than the depersonalized

market. From the management of individual companies the idea extends to

political principles about society as a whole and economic organisation in

particular.

Stakeholder awareness poses a direct challenge to a one dimensional share

holder centric management approach. The labour as a full social partner in work

places is an important principle of the continental European particularly

German, Dutch, French, Scandinavian, legal tradition which has been carried

into European Union labour law. The two sides of industry were empowered by

the Maastricht protocol on social policy to reach binding agreements which will

themselves become part of European law, so both trade unions and business

associations are more important than ever before in setting standards at work.

The ideal is that all parties work together for a common goal and obtain shared

benefits opting in to businesss project. Employees at all levels are more

productive so it is asserted if they understand and feel part of the companys

plans2

Stakeholder theory proposes that all parties affected by the activities of a

company should be given a place in corporate decision making. This may be

2the European work councils derivative 94/45OJL 254 / 64 (1994)


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direct participation, by representation or other appropriate consideration of their

interests3. As a matter of general principle stakeholding seeks to achieve a

balance of risks and reward of rights and responsibilities that is properly

inclusive and fair in a way that the present order has not been. The advocates of

stakeholding approach often contend that it enhances both social justice and

economic prosperity. Trusting relationships are said to foster investments and

developments which in turn produces which in turn produce rewards for all

stakeholders. From a stake holding perspective the substantive questions are

whether employee and customer interests could be more effectively protected

and whether other stakeholder groups are entitled to recognition.

There are practical issues around involvement of all such bodies quite apart

from arguments of principle. Direct participation in decision making at board

level is one possibility. Another is the creation of enforceable duties on the part

of directors to have full regard to stakeholder interests and to consider

appropriate representations when making their decisions. Greater shareholder

involvement should itself be part of stakeholding agenda for public companies

in Britan.

Just as in a democratic state parties affected by decisions are involved in

making of those decisions so in a company relevant groups should appropriate

input. The democratic model can have a powerful influence on corporate

governance thinking. Stakeholder theory goes beyond both the simple attempt

to describe the realities of substantial corporations and the assertion that

stakeholder satisfaction produces better results in long run. At its core is the

moral imperative of balancing varied property rights none of them absolute but

all of them valid.

Donaldson and Preston express this normative case of stakeholding as follows:

3smith , NC, Morality and Market, 1990 pp 55 et seq and 84 points out that board level participation os mot omly the

option for stakeholders and may be impractical because of conflicts of interests


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1) Stakeholders are persons or groups with legitimate interest in proceduraland / or substantive aspects of corporate activity. Stakeholders are

identified by hteir in the corporation whether the corporation has any

functional interest in them .

2) The interests of the stakeholders are of intrinsic value. That is, each groupof stakeholders merits consideration for its own sake and not merely

because its ability to further the interests of some other group, such as the

shareowners.

That is no conflict between the moral assertions that all stakeholders have

intrinsic value and the empirical claim that a balanced stakeholder

approach will produce better long term results for the benefit of all parties

The Japanese and German systems appear to come closer to optimising long

term private and social returns. The greater focus on the long term corporate

positions encouraged by an ownership structure and governance process that

incorporates the interest of employees, suppliers, customers and the local

community allow the Japanese and german economies to better capture the

social benefits of private investment4

Porter s comparison was with US but UK is open to similar criticism.

Philosophical and political dissatisfaction with the Anglo American system has

been widely expressed in recent years. As lord Dahrendorf succinctly put it

Companies are more than profit machines. As employers as purchasers and

suppliers and as centres of community life they are nub of a network of

stakeholders. Shareholders can dispose of their assets; stakeholders are at risk of

being disposed of themselves5

THE USES OF STAKEHOLDING

4Porter .M, Capital Choices :Changing the way America invests in the industry in Chew, D, Studies in

International Corporate finance and governance systems 1997, p135 dahrendorf, R on the dahrendorf report (1996)67 political quarterly 195


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The concept of stakeholding can be seen as one suggestion among many of how

things should be done within a company. Alternatively it could be regarded as a

description of matters of fact with no implications whatsoever for the improved

conduct of business. The real strength of the idea lies in the fact that it leads on

from a descriptive analysis of how companies function to a suggestion od how

to make themn operate better, grounded in a principle of fairness and

inclusiveness.

Theoretical writing about stakeholding has fallen into following categories:

1. Descriptive observations the way the things are interdependence ofcorporate participants

6

2. Instrumental procedures- focus on business objectives analysis to aidprofitability

7

3. Normative statements pronouncements on ethics, principles ofparticipation business

8

Competitive pressure is not always an absolute or effective restraint on

behaviour, especially for large companies. The market generally does not

preclude social action and certainly not prevent the fair and ethical treatment of

employees and suppliers.9

At the perspective level lies the justification for

stakeholding on which all others are founded. This analysis goes to the heart of

corporate activity and its purpose. Implementation then involves understanding

how the firm works and that corporation as well as competition is needed to

6 eg hill ,CWL and Jones TM, stakeholderagency theory (1992) 29 journal of management studies 1317

eg Preston ,LE and Sapienza HJ Stakeholder management and corporate performance (1990) 19 Journal of

behavioural economics 361

8eg Kuhn , JW and Shriver DW ; beyond success corporations and their critics in the 1990s 1991.

9

Prahlad,CK Corporate Governance or Corporate value added? Rethinking the primacy of shareholder Value,

1997, p 48


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allow company to continue and thrive. The leadership attention then turns to

making it more effective by applying a system to discover and compare the

needs and wishes of the various groups involved.10

To the extent the law restrains the board in looking at any interest other than of

the shareholders as an ultimate goal, it restricts the scope for investment and for

the company to play its part in life of the economy and society to the full. This

is a situation the stakeholding perspective could help to change if it were

reflected in the company law.11

The board of directors would not be confined to

looking only at the impact on dividend returns and share prices. In other way, it

would be subject to more effective scrutiny as mire stakeholding groups were

empowered to monitor corporate decisions and protect their expectations. There

is further competitive advantage to be gained by developing appropriate

committed relationships with customers and suppliers in industry, but at present

UK law gives little or no support to this where arguably it should do so.12

THE IDENTIFICATION AND DEMANDS OF STAKEHOLDERS

The original perhaps the broadest definition of corporate stakeholding refers to

a stakeholder as any party which can affect or be affected by the activities or

business.13

The individuals and groups who have a direct impact on the

productive work of a public company are naturally the most pressing in terms of

day to day considersation , while others come into play at the relevant times and

can cause problems to the management if mishandled or forgotten. All

stakeholders ought to be treated as valuable in their own right not simply as

10Freeman , Stakehikder thinking : the state of thinking

11Williamson,JThe road to stakeholding 1996, 67 Political Quarterly 209

12Deakin, S, Lane,C and Wilkinson,F, Trust or Law? Towards an Integrated Theory of Contractual Relations

Between Firms ,1994 , 21 Journal Of Law and Society 329

13Freeman,RE Strategic Management, A Stakeholder Approach,1984, p25


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means to the end set by others , nor does any one group have an absolute claim

to priority14

CLASSIFICATION OF STAKEHOLDERS

Stakeholders can be divided primary and secondary on a broad basis. Primary

stakeholders are those who count on a strictly business basis without whom the

business simply could not function they consists of managers, employees,

shareholders, and suppliers. Secondary stakeholders have influence and effect in

specific and important situations of concern to them. The national and local

media which are central to corporate external communications, the communityand environment, all of which can be essential to success to critical times, fall

into this category.15

Another division, suggested by Professor David Wheeler and Maria Sillanpaa,

is that social and non social classes of stakeholder. These are said to be

distinguishable by the fact that the former can be communicated with directly

by the while the later cannot.

14Sheikh,S, Corporate Social Responsibility, Law and Practise,1996,p 171

15Goldenberg, Shareholders v. stakeholders : the bogus argument,1998


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CHAPTER 2

ROLE OF EMPLOYEES AS STAKEHOLDERS

Sharing ownership with employees might be good way to stimulate greater

productivity. For more than a century major corporations have been

experimenting with a variety of such plans including stock options, profit

sharing and direct employee ownership of stocks. Many employers also have

embraced non-hierarchical workplace themes designed to encourage employees

to think and act like owners, such as decision making, team work and fewer

levels of management. These are often summed up by terms such as employee

participation, employee involvement, or high performance work systems.

The traditional approach dating back to 1883 in Hutton v. West Cork Railway

Company aligns the best interest of the corporation with the interest of the

shareholders. Shareholders wealth maximization remained key focus and

consideration in the governance corporation for such a long time. As the

corporations structure, organization changed from the earlier time huge

LEGAL STATUS OF EMPLOYEES AS STAKEHOLDERS

In different countries the legal status of employees under corporate law are

different. In most of the common law countries, employees are frequently not

treated justifiably, fairly or with respect because corporate decision-making

focuses almost exclusively on increasing the shareholder value. This kind of

approach is ultimately detriment to the corporations itself because without


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treating the employees rightfully they wont be giving their best to the

company. So employees should be considered as an important stakeholder in the

present day corporation. The interest of this stakeholder group should also be

taken care off at par with shareholders interest and the directors should be

guided by some statutory provision in each country so that they can take

decision balancing the interest of all stakeholders in the corporation.

Employees can be considered as the primary stakeholder among all the

stakeholders other than the shareholders. This position can be better explained

by the human capital theory rather than the traditional (shareholder primacy

theory) or the progressive (stakeholder theory). According to this theory

employees are investors of human capital with corporate expectations

equivalent to those of shareholders who are investors of financial capital. In a

way employees are more at risk in view of the fact that shareholders who may

invest in various corporations, employees are unable to diversify their

investment as effectively. Moreover compared to other stakeholders, employees

are permanently tied to their employer corporations and they are not free to

associate with other corporations so effortlessly. Other stakeholders like

customers and suppliers have more option to enter into other business deals.

The critics of the stakeholding theory question whether all the stakeholder

interest be treated equally, along the lines of a ulitarian calculus. Few defenders

of the stakeholder approach advocate treating all interest equally. Alternatively

the stockholders interest has special priority. If this route is taken, then the

stakeholder principle is merely an extension of the profit principle.16

EMPLOYEES PARTICIPATION MECHANISM

Employees participation in managerial decision doesnt have quite the pedigree

that the financial incentives do, but the idea still dates back nearly a century. In

16 Fieser, J , Do business have moral Obligations beyond what the law requires


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the 1920s and 1930s some British companies looked for ways to boost

productivity and quality by making work more meaningful and less repetitive.

Several high profile factory experiments attracted great interest. The idea of

involving employees in decision making spread rapidly after World War II in

both Europe and United States. The German took a top down approach setting

up formal factory councils, or groups of elected worker representative on their

boards of directors. Companies there also must have employee representative on

their board of their board of directors. So called works councils remain a key

facet of German labour relations today. In 2002 the European council decided to

establish similar councils at most of the companies of most of its companies in

the coming years

Employee participation in corporate governance systems can be found in many

countries and corporations throughout the world17

. Examples include:

Right to consultation - where employees must be consulted on certain

management decisions. This right increases transparency of management

decisions and allows employee opinion to ameliorate the asymmetry of

information between management and the market Duties of board members to

consider stakeholder interests. This right reinforces accountability by protecting

stakeholders

Right to nominate/vote for supervisory board members. In many cases

employee participation on the board is mandated. This right creates a check and

balance system between management and the supervisory board, which in turn

creates the perception of greater fairness

Compensation/privatization programs that make employees shareholders,

thereby empowering employees to elect the supervisory board, which, in turn

holds management responsible

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BARRIERS OF EMPLOYEES TO PLAY A FULL ROLE IN CG

As employee shareholders have the interest and incentives to play a full role in

corporate governance, the barriers - in rules and in the institutional capacity to

enforce those rules are following

Voting - In many companies, employees cannot in practical terms vote their

shares, for example they may have their shares voted en bloc by management.

Access to information - If employees have the right to vote, they often have

insufficient information on which to rely.

Access to independent advice - Without access to independent advice,

employees are often guided to voting in a manner consistent with management.

Fragmented voting bloc - Employee voting needs coordination. The

fragmented voting bloc creates the free rider problem and makes it hard to have

influence

Retribution - As well, some employees may fear retribution if they vote against

management or otherwise attempting to increase the voice of employees within

the corporation.

METHODS TO ENSURE THE PROTECTION OF EMPLOYEES

Possible methods of ensuring that employees can contribute their voice as

shareholders include:

The ballot. Make sure votes are held and counted by an independent registrar.

Also, by making the right to vote unalterable by management, employee

shareholders are protecting their rights as shareholders

Prohibiting management from voting employee shares places the right to the

ballot back in the hands of its legitimate owner.
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Full disclosure. By releasing financial and non-financial information, the

corporation improves transparency and employees are enabled to make better

voting decisions

Pooling employee shares into an independent fund controlled by employees

eliminates the fragmented voting bloc problem. Additionally, the fund could be

responsible for collecting dividends, for providing independent advice and, if

necessary, for mounting shareholder actions, such as pressing law suits.

Confidential voting. A crucial element in any proxy voting system,

confidential voting eliminates the possibility of a threat of retribution. Bypreventing management interference, it also promotes the principle of fairness.

Technological advances such as the internet make confidential voting more

accessible

Cumulative voting. Creates a system whereby individual shareholders may

pool their votes in order to weight their voice for a particular board member.

Employee shareholders could seek representation on the supervisory board.

FACTORS AFFECTING THE CAPACITY AND MOTIVATION TO

REPORT18

Professional association

The willingness of organizational members to report violations is important

because of the difficulty in monitoring internal behaviour, especially

behaviour that is purposely concealed. Encouraging members to voice

observations of wrongdoing could allow organizations the opportunity to

change illegal or unethical practices before they become dependent

upon the suspect behaviour. The literature suggests that, in addition to

18Factors of Employees Effective Voice in Corporate

Governance* STEPHEN E. CLAPHAM1,** and ROBERT W. COOPER2, Journal of Management and

Governance (2005)
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personal values, ethical behaviour may be affected by various factors

related to corporate policy and organizational climate.19

In addition,

organizational members have strong affiliations with sub-groups within the

organization (e.g., departments), and/ or professional organizations that

exist outside the organization.

Organizational culture and policy for voice

There are factors in the work environment that may influence how one

reacts when faced with an ethical dilemma. Fritzsche (1987) indicates that

corporate policy may significantly influence ethical behaviour. Murphy(1988) suggests that corporate policy related to ethical behaviour can be

implemented through both (1) formal organizational mechanisms such

as codes of ethics, ethics training programs and conferences, and an

internal appeals process, and (2) informal organizational climate (i.e.,

corporate culture).

Personal values

Individual attributes such as personal moral values and personal goals and

motivations, as well as ones personal environment as reflected in

support and/or pressures from family and friends, are commonly

recognized as potentially important factors that may affect how one

responds to ethical dilemmas encountered in the course of

business.20

To be sure, individuals have a lifetime of interactions with

education, religion, family, friends, colleagues, community, the media, etc.

From those lifetime experiences we form, either consciously or

unconsciously, our own individual moral person. While previous

studies have suggested that individuals who report wrongdoing are

19Trevino, 1986; Fritzsche, 1987; Murphy, 1988; Sims, 199220Bommer et al., 1987; Fritzsche, 1987
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strong-willed with high levels of self-esteem, there is little empirical

evidence to draw a com- posite personality type.21

Rothschild and Miethe

(1999) found that a large proportion of whistle-blowers indicated that

personal values drove them to report the behaviour that they believed was

wrong, harmful, or illegal. Thus it is expected that individuals would

strongly rely on their own individual morality to recognize and report

improprieties in the work environment.

CHAPTER 3

EMPLOYEES ROLE IN CORPORATE STRUCTURE OF DIFFERENT

COUNTRIES

UNITED STATES

The so-called "Anglo-American model" (also known as "the unitary system")

emphasizes a single-tiered Board of Directors composed of a mixture ofexecutives from the company and non-executive directors, all of whom are

elected by shareholders.22

In US in contrast to Germanys codetermination model or Japan model in

which directors are implicitly allowed to balance the competing interest of

21Jos et al., 198922 Mallin, Christine A., "Corporate Governance Developments in the UK" in Mallin, Christine A

(ed),Handbook on International Corporate Governance: Country Analyses, Second Edition , Edward Elgar

Publishing, 2011
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employers and with shareholders US does not provide for the participation

of workers. Mainly in US shareholder primacy model law prevails and the

interest of the workers is defined through contract and governmental

regulation. In American corporate governance culture is characterised by

absence of employee voice. The free market situation states that since

employees are protected by contractual mechanisms like collective

bargaining , employees do not play a role in corporate governance

mechanisms. The inadequacy of private contracts and other practical and

legal hurdles avert employees from negotiating against corporate

opportunism. But pension fund schemes have a significant role in

American corporate governance system.

The employees role in corporate governance in US can be analysed at three

different levels according to . First, at the shop floor, workers have access

to much information about product information about product production

that would benefit managers. Second, at the collective bargaining level,

workers do not have right to bargaining over plant closings and

relocations. Finally at the strategic decision making level, the boardroom

culture still resists efforts to include human capital perspectives.

GERMANY

Germany and Holland, require a two-tiered Board of Directors as a means of

improving corporate governance.23

In the two-tiered board, the Executive

Board, made up of company executives, generally runs day-to-day operations

while the supervisory board, made up entirely of non-executive directors who

represent shareholders and employees, hires and fires the members of the

23 Tricker, Bob,Essentials for Board Directors: An A-Z Guide, Second Edition , Bloomberg Press, New York,

2009
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executive board, determines their compensation, and reviews major business

decisions.24

German corporate governance fundamentals and practices are generally based

on the provisions of the German Stock Corporation Act (Aktiengesetz), the

German Codetermination Act (Mitbestimmungsgesetz), and the German

Corporate Governance Code. In principle, this also applies to a European

Company (SE), which is, however, also governed by the provisions of the SE

Regulation, and to which the national codetermination laws do not apply.

Instead, codetermination in the SE is governed by the provisions of an

agreement on employee involvement or the regulations provided by the law on

employee involvement in a European Company (SEBG).25

The supervisory boards of major German stock corporations and SEs are

subject to employee codetermination and are comprised of representatives of the

shareholders and employees. Traditionally, the shareholder representatives on

the supervisory board have a good understanding of the business activities of

the company. Depending on the companys total number of employees, up to

one-half of the supervisory board members will be elected by the companys

employees. The chairman of the Supervisory Board is a representative of the

shareholders, and the deputy chairman or one of the two deputy chairmen

common to an SE is a representative of the employees. In the event of a tie vote,

the deciding vote is cast by the chairman.26

UNITED KINGDOM

Corporate governancein the UK mediates the rights and duties among

shareholders, employees, creditors and directors. Since theboard of

24 Hopt, Klaus J., "The German Two-Tier Board (Aufsichtsrat), A German View on Corporate Governance" in

Hopt, Klaus J. and Wymeersch, Eddy (eds), Comparative Corporate Governance: Essays and Materials, de

Gruyter, Berlin & New York, 199725http://www.sglgroup.com26 ibid
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directorshabitually possesses the power to manage the business under a

company constitution, a central theme is what mechanisms exist to ensure

directors' accountability. UK law is "shareholder friendly" in thatshareholders,

to the exclusion ofemployees, typically exercise sole voting rights in the

general meeting. Thegeneral meetingholds a series of minimum rights to

change the company constitution, issue resolutions and remove members of the

board. In turn, directors owe a set ofdutiesto their companies. Directors must

carry out their responsibilities with competence, ingood faithand undivided

loyalty to the enterprise. If the mechanisms of voting do not prove enough,

particularly for minority shareholders, directors' duties and other member rights

may be vindicated in court. Of central importance in public and listed

companies is the securities market, typified by theLondon Stock Exchange.

Through theTakeover Codethe UK strongly protects the right of shareholders

to be treated equally and freely trade their shares.27

INDIA

India'sSEBICommittee on Corporate Governance defines corporate

governance as the "acceptance by management of the inalienable rights of

shareholders as the true owners of the corporation and of their own role as

trustees on behalf of the shareholders. It is about commitment to values, about

ethical business conduct and about making a distinction between personal &corporate funds in the management of a company.

28SEBI makes guidelines for

employees stock option plan also.

27http://en.wikipedia.org/wiki/United_Kingdom_company_law28 "Report of tbe SEBI Committee on Corporate Governance, February 2003
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CHAPTER 4

EMPLOYEES STOCK OPTION PLAN

Employee Stock Option Plan (ESOP) is a scheme through which a company

offers Stock Options to the employees based on their performance. Under an

ESOP, the employees have right to buy the shares of the company on a

predetermined date at a predetermined price. ESOP is an incentive to the

employees to perform better and improve shareholders' value. In addition to the

financial gains to the employees, ESOP also creates a sense of belonging and

ownership amongst the employees.

Stock and Exchange Board of India (SEBI) guidelines define employee stock

option as option given to the whole-time Directors, officers or employees of a

company which gives such Directors, Officers or employees, the benefit or right

to purchase or subscribe at a future date, the securities offered by the company
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at a predetermined price. This definition has been incorporated based on

similar definition contained in section 2(15A) of Companies Act, 1956.

Important terms

29

:

Grant date - The date on which the company grants an option to its employee.

Option price - The price at which such shares in a scheme are offered. It is also

known as the strike price or grant price. Normally such option price would

be below the market value/ fair value of the shares on the date of grant.

Vesting date - An ESOP would provide for a date on which an option is vested

with employees and time frame over which the stock option would vest with

employees (Vesting period).

Exercise period - The employees would be given a time period, called exercise

period, within which they are required to exercise the option. The date on which

employees exercise this option is known as exercise date.

The different ways in which a company can offer ESOP

There are two ways in which a company can set up an ESOP30

.

(a) Create a Trust (Special Purpose Vehicle) - Depending on the number of

options to be given to the employees, the company will issue shares or options

to the trust. The trust would need funds to buy these shares. For this, the

company can either give soft loans from its own funds or the trust can raise

loans through other sources to meet its financial requirement. The company can

act as a guarantee to the lender to the trust. With the funds so raised, the trust

then acquires shares/options required. The trust repays its loans as and when the

employees purchase the options offered and when they exercise their options by

paying the exercise price.

29 SEBI guidelines30http://www.karvy.com
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(b) Give options directly to employees - The selection of the employees can be

based on performance of the employee, indicated by the annual performance

appraisal, minimum period of service, present and potential contribution of the

employees, and such other factors deemed to be relevant for the success of the

company. Number of options per employee can be determined taking into

consideration, the grade, level, years of service, salary, etc. These selections

would entirely depend upon the objective of the company for setting up the

ESOP.

The real advantage of ESOPs is that, the exercise price remains fixed over the

term of the option. So, the employee would exercise his option when the market

price of the shares goes substantially high and he would gain on the difference

between the market price and exercise price.

Different types of ESOPs31

ESOP can be a one-time plan or an ongoing scheme depending upon the

objectives that the company wants to achieve. ESOPs can be in the form of

ESOS (Employee Stock Option Schemes), ESPP (Employee Stock Purchase

Plans), Compensation Plans, Incentive Plans, SAR/Phantom ESOPs etc.

Employee Stock Option Scheme (ESOS) - Under this scheme, the company

grants an option to its employees to acquire shares at a future date at a pre-

determined price. Eligible employees are free to acquire shares on vesting

within the exercise period. Employees are free to dispose of the shares subject

to lock-in-period if any. Generally exercise price is lower than the prevalent

market price.

Employee Stock Purchase Plan (ESPP) - This is generally used in listed

companies, wherein the employees are given the right to acquire shares of the

31 ibid
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company immediately, not at a future date as in ESOS, at a price lower than the

prevailing market price. Shares issued by listed companies under ESPP will be

subject to lock-in-period, as a result, the employee cannot sell the shares and/or

the employee has to continue with the employer for a certain number of years.

Share Appreciation Rights (SAR)/ Phantom Shares - Under this scheme, no

shares are offered or allotted to the employee. The employee is given the

appreciation in the value of shares between two specified dates as an incentive

or performance bonus, that is linked to the performance of the company as a

whole, as reflected in its share value.

SHAREHOLDERS APPROVAL FOR ESOP32

The ESOP shall be approved by the shareholders by a special resolution. The

resolution shall contain terms and conditions of the Plan which inter-alia shall

include the following:

a. Identification of classes of beneficiaries entitled to participate In the ESOP.

b. Vesting of the Stock Option

c. Period of exercise and process of exercise.

d. Exercise price or pricing formula.

e. The appraisal process for determining the eligibility of employees to the

Stock Option Plan.

f. Upper limit on the quantum of stock options to be issued in the aggregate.

Accounting Treatment & Option Valuation

32 SEBI guideline
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SEBI Guidelines permit accounting for ESOP Option by intrinsic value method

or by Fair Value Method as adopted by the Company. The guidelines provide

that the accounting value of options shall be equal to the aggregate overall

employee stock options granted during the accounting period, of the intrinsic

value of the option or, if the company so chooses, the fair value of the option.

The guidelines also articulate that the employee compensation cost shall be

amortised on a straight-line basis over the vesting period. However, if

compensation cost is computed using the intrinsic value of stock options, the

impact of difference between Intrinsic Value method and Fair Value method as

regards compensation cost, profitability and EPS of the Company should be

disclosed in the Directors Report.33

Rules and Regulations

Companies Act

Issue of stock options requires approval of shareholders by way of a special

resolution as per section 81(1 a). This is not applicable for private companies

who can issue stock options without shareholder approval but approval by the

board of directors.

Income Tax Issues

For employees:

Till recently, the difference between the cost of the share to the employees and

market value on the date on which an employee got the share would be taxed asperquisite in addition to capital gains tax payable by the employee on sale of

those shares. However with the recent announcement by the Finance Minister

the perquisite tax has been removed. Tax is now payable only at time of sale of

shares as capital gains.Since perquisite tax has been removed employers are not

liable for tax deduction at source, thus removing administrative inconvenience.

33 ESOP SchemesAn Insight, Sanjoy Bank
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For the company:

As per SEBI guidelines listed companies have to account for ESOP by treating

the same as an expense. As yet there is no clarity whether this expense will be

allowed as deductible expense by the Income Tax authorities.

ESOP in America

The number of ESOPs in United States steadily through the 1970s then soared

dramatically, in the 1980s. During that decade, thousands of companies rushed

to put stock in workers hand to gain the tax breaks or to ward off takeovers by

putting a big chunk of their ownership into friendly hands of employees many

also acted out of a conviction that employee owners would give a boost to the

bottom line. The growth of ESOP stalled out in 1990s in part because some

companies had set up modest ESOPs without making any real commitment to

creating a culture of ownership. As a result they found idea difficult sustain.

Employees also lost their interest at companies that didnt set up ESOPs large

enough to give them a meaningful stake.

At the same time, the treat of takeovers diminished among public companies . in

1992 the accounting profession also changed the rules for how public

companies book ESOP purchase on their income statements. Because the new

method made corporate income look smaller, it put downward pressure on an

ESOP companys stock. ESOP but flourishes in privately held companies. One

big reason is the federal tax incentives they provide their founders and family

owners, who can be excused from capital gains taxes if they sell more than

thirty percent of the business to employees. The membership of the countrys

two major ESOP groups, the ESOP Association and National Center for

Employee Ownership, increasingly are made of such companies, which now

often have a majority of their stock in the hands of employees.
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CONCLUSION

Employees need to be developed and encouraged through genuine involvement.

It is for the governments to set social priorities, but large companies need to fall

in line. The change to an inclusive approach will not happen without the

understanding and permission at least of institutional managers who themselves

ought to be planning for long term growth. Motivation and effectiveness are

likely to improve dramatically when all stakeholders understand the aims of the

company. Employee participation mechanisms enhance the wealth creation of

the corporation ultimately. In the best interest of the corporation employees

should be provided with their rights as stakeholders.
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stake holder theory

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