A summary of the CIPD Executive Briefing
The executive briefing gives an overview of how employee share schemes fit into a company and the roles they fulfil. The emphasis is on philosophy, strategy and implementation rather than on the detailed technical issues around tax and accountancy issues.
As well as examining such topics as the rationale for employee plans, the evidence as to whether they work, and communication, it also looks at employee share schemes from the perspective of employee groups, the new accountancy, tax and regulatory framework and the topics of administration and evaluation.
This publication is targeted at HR managers and reward specialists who are examining plans; managers interested in learning how share plans can be used to contribute to improved employee engagement and performance in a tax efficient way; and share scheme experts who want a broader picture of how such schemes fit in with people management polices and practices.
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The case for employee share plans
Employee share ownership has become an important and common feature of UK corporate culture, largely through the desire to make employees act like owners and to care more about the company as a whole rather than their personal position.
Over 2,000 companies operate all-employee share plans in the UK, covering an estimated three million employees. Employee share plans are popular in quoted companies, and particularly the larger quoted companies. On top of this are all the executive schemes that are not approved by HMRC.
There is evidence that companies which offer share ownership programmes perform well in comparison to their peers who do not offer such programmes. Companies that have made a public commitment to employee ownership and to being employee-owned companies can be demonstrated to be relative high performers.
However, if employee share plans are to provide a competitive advantage they must be part of a coherent policy, which is aligned both with the corporate strategy and the requirements and expectations of employees.
The tax, legal and regulatory framework
For accounting periods beginning on or after 1 January 2005, new accountancy regulations have come into force for listed companies. International Financial Reporting Standard (IFRS2) Share-based Payment and its UK equivalent, (FRS 20) requires share-based payments to be recognised as a profit and loss account expense. This now means that there will be an accounting charge for all share-based payments. FRS 20 applies to private companies for accounting periods beginning on or after 1 January 2006. Companies will now look more closely at the return on their investment in share plans rather than regarding them as “free”.
When planning for the implementation of a new share plan (or for the renewal of an existing plan), companies must consider the tax, legal and issues and regulatory frameworks within which the plan will operate. Compliance should be carefully checked by taking specific advice from a professional advisor at the time each share plan is introduced or renewed.
Types of schemes
Although there appears to be a plethora of highly complex arrangements, in essence there are only four types:
- Under option plans, the employee is given an opportunity to acquire shares in the future at a price fixed when the option is granted, and the employee benefits from share price growth above the option exercise price.
- Other plans give employees the opportunity to buy shares from pre-tax salary or their bonuses, and some companies give free shares to match those purchased by employees. The free shares are sometimes subject to forfeiture if the employee leaves and/or fails to meet certain performance conditions.
- In some cases, employees buy or are given shares which they may have to forfeit if they leave their employment or do not satisfy performance targets. These are sometimes called ‘restricted shares’.
- Some companies promise to give employees shares in the future if certain performance conditions are met. These are often known as ‘performance shares’.
The share plan arrangements for directors and senior executives are mainly about achieving alignment with shareholder interests and providing competitive remuneration sufficient to attract and retain executives of suitable calibre.
The expense of acquiring restricted and performance shares and the absence of an accounting cost for options has traditionally meant that middle managers have been rewarded with option grants rather than with restricted or performance share awards. Now that options must also be recognised as an expense there has been a move away from options altogether for this group.
One of the ways that companies seek to obtain greater engagement of their non-management employees, an understanding of the business process and the way that their behaviour can affect corporate results, is to get active participation in employee share ownership opportunities.
What to consider when introducing a new plan
A company’s board of directors must give careful consideration to the introduction of a new employee share plan. New plans must be justified both in the context of the company’s business and in the market in which the company operates.
Some of the main factors that the board will need to analyse are: Does the share plan reflect and underpin the company’s reward philosophy and strategy and support corporate objectives and company values? Will participation lead to the appropriate positioning of the pay ‘mix’ between fixed and variable pay? What are the objectives that the company wants to achieve from the scheme? What will the positive and negative impacts (in financial as well as human capital terms) on the company be?
Where the share plan is intended to reward or encourage particular behaviours or returns then performance conditions are likely to be appropriate. Share plans for directors and senior management usually incorporate performance conditions, and the Association of British Insurers (ABI) make clear in their guidelines that corporate governance best practice requires performance conditions in these circumstances.
The success of the majority of employee share plans will be directly related to the way in which they are communicated at the launch and as part of an on-going process. Employees must understand what is on offer, how they sign up, what the implications are of participation in the plan and where they can obtain further information both at the time of launch and during the course of the plan life. Where the plan is conditional on the achievement of future events they need to know what those events are and the influence they have over them.
While the decision to implement a share plan is a simple step, many companies fail to realise the extent of administration required to ensure that it is a success. Given the number of administrative issues to be met, companies should consider how best to meet these obligations and whether they want to outsource them.
HR has a crucial part to play in the introduction and subsequent evaluation of an employee share scheme, be it executive or all-employee. From helping to assess what share arrangements are most appropriate for the organisation and its employees to designing an education, launch and communication strategy so that staff appreciate what behaviours and values are being rewarded and why.
Cohen, S (2006) Employee share plans: supporting business performance. Executive briefing. London: CIPD