Private companies’ Employees Stock Option Plans – Part 2

 

In Part 1, we discussed how Employee Stock Option Plans (ESOP) evolved as a corporate incentive for employees. In this part, we will get into the nitty-gritty of ESOPs.

ESOP is designed on the principles of partnership. The employees, by nature of their contractual status, are not members of the company and cannot usually participate in the profits or affairs of the company. ESOPs provide an opportunity, an exception so to speak, for the employees to be part of the company as any other shareholder while simultaneously retaining their status and legal character as an employee. ESOPs allow the employee to wear two hats at the same time. An employee member continues to draw salary and perks and will also have the additional right to receive share of profits of the company.

The principal objectives of an ESOP are to (a) attract, retain and motivate talented and critical employees (b) compensate for low salaries and relieve pressure on cash flows (c) encourage employees to align individual performance with company objectives (d) improve communication within the different tiers of the organization (e) increase employee job satisfaction (f) reward employee performance with ownership in proportion to their contribution (g) align employee interest with those of the organisation and (h) encourage employees to create share market value. It is important to point out that public sector enterprises in Pakistan are following Employee Stock Option Schemes to encourage employee participation.

The allotment of shares under a contract of service is permissible under section 73 of the Companies Ordinance, 1984 provided the provisions of section 86 thereof, when applicable, are fulfilled. The contract of service should be made into writing and properly stamped. The registrar of companies is authorised to examine the said contract to ensure that the shares were lawfully allotted.

The shareholders of a company must approve an ESOP for its employees. This has to be done in view of the mandatory requirements prescribed under section 86 (issue of further shares) of the Companies Ordinance, 1984 read with the Companies (Issue of Capital) Rules 1996 and Companies Share Capital (Variation in Rights and Privileges) Rules 2000. For compliance purposes a resolution approving the ESOP must be passed by the shareholders wherein, as per present regulatory regime, they have to waive their respective rights to accept any further shares so issued under the ESOP. This information must be filed before the SECP as well. This is a routine matter. The employment contract may be drafted or amended accordingly.

ESOP must provide whether the option is available to all the employees or a select group of employees according to an eligibility criterion (tenure based, performance based or experience based). The price at which the option shall be exercised must be predetermined. The period(s) in which this option shall vest (“Vesting Schedule”) in the employee must be clearly defined. Timeframe within which the employee must exercise the option should also be mentioned. The lock in period where the employees would be restrained from disposing off/selling the option before the expiry of a certain period of time and the claw back clauses should also be included. An Administrative Committee formed by the company oversees the application and enforcement of the ESOP.

It would be appropriate to add a word of caution here. We must point out that the ESOP will place the employee at par in some matters with the original shareholders. Under the ESOP the employee member may have a right to vote, inspect accounts and there is even a possibility that they may as a minority shareholder seek regulatory action against the company/management. Therefore, it is of utmost importance that an ESOP must be drafted carefully not allowing any transgression on the rights of the investors of the company. These investors have invested in the capital of the company and are legally entitled to receive due returns on their investments, elect directors and ensure the affairs of the company are managed properly. Moreover, it must be ensured that ESOP covers those exceptional cases where the employee members may create unnecessary impediments in the operations and affairs of the company. Furthermore, restrictions on employee members on transfer of shares must be put in place. Lower thresholds may be preferred so that influence of original shareholders is not diluted or compromised. ESOP must also cater for cases where an employee member is removed or dismissed from service on disciplinary grounds.

It is encouraging to note that the SECP in its draft of the new proposed company law has added a specific clause about ESOPs. It is desirable that exemption provided to public companies from application of section 86, may also be added in the new law for the convenience of private companies and their employees. We can follow the examples set in many developed corporate jurisdictions. A peek into our neighbouring India’s company law reveals that the law on private companies’ employee stock options is very clear and the regulator there has vigorously promoted this idea.

In Pakistan, there is a visible growth in adopting the corporate structure for business and other commercial purposes. However, we have seen that majority of individuals who form companies are, more often than we’d like, ignorant about the recognised corporate practices, ethics and principles. These companies are registered as corporate enterprises on paper only as they lack a vibrant corporate structure. The result is that such companies underperform as they are unable to tap the potential a corporate business structure offers to its shareholders, investors and stakeholders.

It is believed that an ESOP, if properly managed, can be a lucrative investment opportunity. ESOPs have played an instrumental role in attracting and retaining top executives as well as non-executive employees. There is a massive opportunity at hand for our corporate players especially those who are competing globally. Companies engaged in IT, telecommunications, financial, retail and service sectors can benefit immensely by introducing ESOPs for their employees. It is indeed the right time to study and understand the benefits ESOPs offer in terms of employee satisfaction and participation, which ultimately translates into company profits. Our corporate sector must transform itself, remove age old barriers and motivate employees to work hand in hand for a common cause.

 

The writer is a Lahore based corporate lawyer and can be contacted at [email protected]