THE Employee Stock Option Scheme (ESOS), fairly popular in the developed world, is still little understood and almost always avoided by the country’s corporate entities.

ESOS is a type of equity compensation that a company may offer to its workers. These plans give employees the right to purchase company shares usually at a discount. For employees who exercise their right as eligible participants, the key benefit of such equity compensation plans is the opportunity to share directly in the company’s ownership through stock holdings. It provides them with at least an illusion of being the owner of the company they work for.

Public Companies (Employees Stock Option Scheme) Rules 2001 received scant attention. Over the years, several sets of rules, regulations and schemes have come to replace their predecessors on ESOS, but corporate experts point out that like the share buyback or treasury stock schemes none have made a deep impression on company boards.

Even with plenty of cash, most corporate entities avoid the share buyback or treasury stock schemes for fear of being trapped in some intricate maze of rules and regulations, which may change from time to time.

Sponsors don’t want employees to climb up the corporate ladder by exercising stock options and accumulating shares from the market

Companies (Amendment) Bill 2020 suggested various amendments to Companies Act 2O17. The Securities and Exchange Commission of Pakistan (SECP) said while releasing the bill that all major stakeholders had discussed and debated it in line with the international best practices. The bill proposed various amendments to Companies Act 2017 “which mainly relate to (the) protection of minority investors, ease of doing business in Pakistan, introducing an enabling regulatory framework to facilitate start-ups for the promotion of businesses relating to innovation and technology and to improve overall business climate in the country and to remove other anomalies/ambiguities in Companies Act 2017”.

It has to be recalled that Companies Act 2017 was drawn up in haste and promulgated by the previous government regardless of the objections by several parties that pleaded for a debate in parliament. It is, therefore, likely that those who framed the law forgot to mention ESOS and an insertion of a new section (83A) in Companies Amendment Bill 2020 had to be made.

It states: “Notwithstanding anything contained in Section 83 or any other provision of this Act, a company may, under the authority of special resolution, issue shares in accordance with its articles under employees’ stock option and in accordance with such procedure and subject to such conditions as may be specified.”

One reason for the companies to dismiss ESOS is also the cumbersome procedure. The Guidelines for Structuring and Offering of Employees Stock Option Schemes 2016 state the composition of the compensation committee, its duties and responsibilities, methodology for deriving the exercise price, procedure for approval of the schemes, disclosures, format of the application form, list of documents to be submitted with the application and a model scheme. That is an enormous amount of paperwork, which companies wisely choose to avoid.

Owners of smaller, family-owned private firms would laugh at the idea of employee partnership in ownership. But several big companies and some banks that were earlier wholly owned by the government distributed shares on the assumption that it would encourage employees to improve performance of the entities that they now “owned”.

But corporate experts term such distribution of company shares among employees politically motivated. “Did any company start to show stellar financial results following the participation of employees as owners by virtue of share ownership schemes?” asked the head of a local privatised firm.

In the stronger economies, there is always competition among companies to attract top talent and stock options are, therefore, offered as an additional incentive. But company sponsors here loathe seeing an employee climb up the corporate ladder by exercising stock options and then accumulating shares from the market. Nothing could be more terrifying for them than seeing an employee sitting as director in the boardroom. Managements, therefore, avoid the risk and acknowledge extraordinary brilliant employee performances through remuneration in cash as ‘additional annual performance bonuses’ along with an increase in pay and perks. Large cash outflows do impact working capital but corporate bosses accept it as a better alternative.

The principle, however, does not apply to executive directors and CEOs who are already on the board. They are offered share options as part of their compensation package purely to retain extensively experienced and highly qualified men as directors who usually head finance, administration, sales or other key departments.

There are other reasons for companies to avoid ESOS even for senior management employees. The additional shares increase the market float, which instantly dilutes the company’s stock price and lowers its book value. This does not find favour with the company’s existing shareholders and creditors in times of escalating stock prices.

Many companies offer employees the opportunity to use the call option. They give the employee the right to purchase the company’s stock later at the price that prevails at the time of the offer of the scheme. ESOS taken at the time of the offer may go wrong if the price of the company’s stock takes a steep dip. But in a raging bull market like the present one, those who exercise the offer may make a fortune.

Published in Dawn, The Business and Finance Weekly, August 4th, 2020