CIPD - Employee share ownership

Pay and reward

Revised August 2008

This factsheet gives introductory guidance. It:

gives details of currently available employee share schemes
considers reasons for introducing an employee share scheme
gives details of organisations and publications providing further information
includes the CIPD viewpoint.

Background

Employee share schemes, where used, generally form one element of a reward package. In the broadest terms, schemes:

are offered either to all employees or else to selected employees (generally senior executives) only
are approved by HM Revenue & Customs (HMRC – formerly the Inland Revenue) or unapproved; unapproved schemes confer no tax advantage
range from those where the employees pay the full price for shares to those where the shares are given free or where options over shares are granted at a discount.

According to the latest WERS survey¹, around 20% of workplaces covered had employee share ownership plans. By size, 1% of small employers has such arrangements, compared with 5% of medium-sized firms and 44% of large-sized companies.

Advantages and disadvantages of employee share schemes

Advantages to employees of buying or receiving shares or options over shares

As shareholders, employees may gain a better understanding of the financial performance of their company.
Shares give a stake in the future growth of the company and employees benefit from the success they are creating.
With free shares, employees gain a financial benefit at no cost to themselves.
Future income in the form of dividends or capital gain if shares are sold at a profit.
Regular savings direct from salary.

Disadvantages to employees of buying or receiving shares or options over shares

Increased financial dependence on the company; if it runs into difficulty, employees risk losing not only their jobs but also much of the value of shares held in the company share scheme (as examples, Marconi employees facing redundancy in September 2001 also saw the value of shares held in the company scheme reduce by 97% over the previous 12 months, and Enron, where employees held shares in their accounts).
Lower-paid employees often prefer bonuses in the form of cash-in-hand rather than shares.
Much of the benefit is time-related, which may tie employees to jobs which they might otherwise prefer to leave.

Advantages to employers of employee share schemes

Shares are regarded as a good recruitment and retention tool.
Share ownership can encourage employee loyalty and retention.
Share ownership may deliver improved performance (although evidence supporting this view is not as readily available as might be expected).
Paying employees in shares can reduce cash flow problems for cash hungry businesses, although it may dilute the equity.
Linking the bonuses of top executives to share price aligns their interests with those of their shareholders.
Awarding shares can encourage skill development and staff retention.
Using shares can encourage employee involvement and participation.
Tax benefits:
- corporation tax relief on the cost of setting up the plan, including the provision of shares
- normally no employers' NI where the shares are held for the statutory minimum number of years.

Disadvantages to employers of employee share schemes

If the share price falls, this may lower morale and cause recruitment and turnover problems.
There is a high administration overhead, both short-term in getting the plan approved and communicating it to employees and long-term in managing the relevant records for performance-related schemes.
Negative connotations of some 'fat cat' executive share option schemes.
Possible dilution of other shareholder interests.
Risk of arousing unrealistic expectations.

Details of currently available approved schemes

The schemes detailed below are those which have been approved by HMRC and, as such, attract a tax advantage. Share schemes are a complex area - the latest information is available from HMRC (see Useful contacts section below).

Share Incentive Plan (SIP)

This was introduced in the Finance Act 2000 and is thus the newest of the approved all-employee share schemes. Formerly known as ‘All-employee share ownership plan (AESOP)’ the scheme was renamed in October 2001. Four types of share are available under the scheme: free shares, partnership shares, matching shares and dividend shares. Under SIP, employers can allow staff to join the scheme whenever they want to.

According to ifs ProShare’s survey of companies offering SIP:

70% of firms offer partnership shares
36% of companies include dividend shares
47% provide matching shares
28% of companies offer free shares.

Savings-related schemes - also known as Save-as-you-earn (SAYE) schemes or ShareSave

Introduced in the Finance Act 1980 as all-employee schemes - everyone must be offered participation on ‘similar terms’. Employees are given a share option ie a right to buy a certain number of shares at a fixed price; these shares can only be bought with amounts set aside under an SAYE contract. The price is determined according to the market price at the date of grant and may be discounted by up to 20%.

Employers can offer options exercisable three, five or seven years from grant. Shares can only be purchased with the proceeds of savings made under a special SAYE savings contract, set up with a bank or building society, for a period of three or five years. For the seven-year option, savings are made for five years only with the savings remaining in the account for the further two years. A tax-free bonus is paid at the end of the savings contract when the employee has the choice of whether to exercise the option to purchase shares. If the share price is below the exercise price, the employee can choose to keep the savings and tax-free bonus. If the employee chooses to exercise the share option, then any subsequent sale of the shares would be subject to capital gains tax if the annual limit (currently £9,600 for the tax year ended April 2009) is exceeded. Employees may transfer shares to a spouse or to an ISA to shelter the capital gain. There is a minimum savings amount of £5 per month, and a maximum of £250 per month across all existing SAYE contracts. Under SAYE, employees can only join the scheme during the invitation period.

Enterprise Management Incentives (EMI)

The Finance Act 2000 introduced an Enterprise Management Incentive scheme. The aim of EMI is to help small independent trading companies attract, retain and reward key people. EMI schemes are different from other employee share schemes in that they do not require HMRC approval in advance, although unlisted companies must submit a share valuation. The EMI exempts gains from national insurance contributions and applied capital gains rather than income tax charges. Companies and employees must meet certain requirements such as the type of trade and the number of hours worked.

Company share option plans (CSOPs) (Finance Act 1996)

Employees are given a share option ie a right, but not an obligation, to buy a certain number of shares at a fixed price at a particular time. This type of scheme is offered mainly as a motivation and reward scheme for senior managers, though a few organisations offer it to all their employees. The aggregate value of all outstanding share options must not exceed £30,000 at the market value at the date of the grant.

Statistics

According to the HMRC, the following number of schemes were live at the end of the financial year 2006-2007:

CSOPs: 3.000 live with an average value of £3,500 per employee
EMI: 8,020 live with an average value of £11,000 per employee
Sharesave: 940 live with an average value of £3,660 per employee
960 SIPs had been approved.

The latest WERS findings reveal that SAYE is the most popular all-employee scheme with 12% of employers offering this type of arrangement, followed by SIP (7%) and CSOP (6%).

Details of currently available unapproved schemes

Many unapproved schemes also exist. These are not illegal in any sense, but their unapproved status rules out any special tax advantages. The list below categorises some of the main types of unapproved schemes. Share schemes are a complex area – the latest information is available from HMRC (see Useful contacts section below).

Unapproved options

Because of the £30,000 individual limit, many companies operate unapproved share option plans that do not need to comply with the rules for CSOPs. However, listed companies are still constrained by the institutional investor guidelines which require that exercise must be subject to the satisfaction of performance conditions, the exercise price must not be less than the full market value of the shares at the date of grant and options should not normally be capable of exercise for at least three years from the date of the grant.

Restricted or performance share plans

An employee is given or buys shares. During a restricted period determined by the company, employees are unable to sell these shares and they are usually subject to risk of forfeiture or sale back at an undervalue if the employee leaves and/or fails to perform. Alternatively, or in addition, employees are promised shares at a future date (commonly after three years) if continued employment and performance conditions are met.

Co-investment/Deferred Bonus Plan

An employee invests some or all of their bonus in the purchase of ‘lodged’ shares, usually held in trust. Companies provide free matching shares, often on a ratio of one matching share for each lodged share. The employees will become entitled to the matching shares if they retain their lodged shares for a specified period (usually three to five years) and performance targets are satisfied.

Share Appreciation Rights (SAR) Plan

Employees are granted a SAR over the same number of shares as someone being granted an option. At the end of the savings period the participant receives all their savings back and receive an award of shares based on the increase in growth of the share price since date of grant. They are often used where local securities legislation does not permit the award of options in an overseas company.

Phantom Share Plans

Companies that cannot use real shares for any reason often operate phantom arrangements. An option is granted to employees over a notional number of shares and on exercise of the option, employees receive an amount of cash equal to the increase in value of the underlying shares, or some other share based performance metric.

Considerations when introducing employee share ownership arrangements

Before introducing any type of employee share ownership programme, an organisation must decide:

Why the programme is being introduced (eg for tax advantages or as part of the overall reward strategy), and how it fits in with the organisation’s objectives.
What type of programme is best suited to the organisation and its personnel.
What will happen during periods of below-expectation performance, and how this will affect the organisation.
What performance targets, if any, will be used and what performance measures will be used to assess whether these targets have been met.
On what basis will the targets be set and how to make sure they are not made too easy or too difficult.
How much to spend on the programme, and its tax implications.
Details of the plan such as employee eligibility and the percentage of shares to be made to employees through the scheme.
Which department is going to be responsible for its implementation and administration (and whether either or both of these tasks will be outsourced).
What methods of communication will be used to give information and explanation about the scheme - presentations, booklets or online via an intranet, or a mixed approach.
What will happen if the scheme needs to be wound up or if the tax incentives change.

Obtaining HMRC approval

The most tax advantageous employee share schemes are those approved by HMRC. The proposal must include comprehensive documented evidence including the notification given to existing shareholders and details of the shares to be provided under the scheme. Preparation of a proposal for submission to HMRC is a detailed task that requires expert guidance.

Assistance in setting up employee share schemes

Advice and assistance in setting up and administering employee share schemes is also available from any number of private consulting firms. If an organisation decides that it would benefit from the services of a consultant, it must ensure that it chooses a firm that has the relevant skills and experience in this complex and rapidly-changing field. Details of consultants and administrators can be found at the ifs ProShare website (see Useful contacts below).

New accounting standards for share-based payments

New accounting standards (IFRS 2) for share-based payments were issued in February 2004 The standard applies for annual accounting periods beginning on or after 1 January 2005 for listed companies and 1 January 2006 for all other organisations. It applies to grants of shares, share options and other equity instruments that were granted after 7 November 2002. Thus, for most companies, the standard will apply for accounts published in 2006. In the UK, the Accounting Standards Board (ASB) issued FRS 20 (IFRS 2) ‘Share-based Payment’ on 7 April 2004, which has the effect of implementing IFRS2 in the UK. Prior to this a charge was only made in exceptional circumstances.

CIPD viewpoint

Although employee share schemes have become an increasingly common and prominent part of the reward package, opinion is divided on how valuable they are in assisting organisations to reach their objectives, particularly in driving up performance. It is clear that employee share schemes, like any reward practice, need careful implementation and must be aligned with broader business objectives and with the organisation’s culture if they are to succeed.

Useful contacts

References

The 2004 Workplace Employment Relations Survey [online]. (2005) London: Department of Trade and Industry. Available at: http://www.dti.gov.uk/employment/research-evaluation/wers-2004/index.html

Employee share ownership