1. Managing Employee Performance and Reward
Concepts, Practices, Strategies
2nd edition

2. Employee share ownership plans
Share bonus plans
Share purchase plans
Share option plans
Employee share plans in Australia
How does employee share ownership work?
How well does it work?
Share plan design and administration

3. Share bonus (or grant) plans
Shares fully paid for by company
Frequently in lieu of additional cash remuneration
May be rolled into retirement fund/trust
Employee receives regular dividends, typically fully franked (i.e. tax-paid)
Vested shares carry full shareholder voting rights
May be ‘restricted’:
Non-vest/holding period (= ‘golden handcuff’)
Performance hurdle/s
Forfeiture
Tax advantages depending on tax law

4. Share purchase plans
Employee pays for shares in part or full (and remains liable for purchase amount irrespective of subsequent movements in share price)
Purchase price is typically discounted (i.e. price is set below prevailing market rate)
Purchase facilitated by low-interest or interest-free loan to each employee (FBT exempt to employer in Australia)
Loan principal and any interest owing commonly repaid by means of pay deductions or firm-operated savings/salary sacrifice plan and/or from dividend entitlements
Shares held in trust during purchase period, with ownership vesting progressively as purchase is paid off
Employee liable for income tax on dividends received

5. Share bonus and purchase plans
Advantages:
Long-term effect compared to cash
Encourage an ‘ownership’ mentality
Encourage long-term commitment and membership behaviour
Support high involvement
Share purchase by employees can be a source of additional capital
Share ownership by employees can prevent hostile takeover
Can serve as a convenient means of accumulating retirement funds
Tax advantages
Can be used to confer equity to employees in firms that do not issue traded shares

6. Share bonus and purchase plans
Disadvantages:
Financial rewards (share price and dividends) linked only loosely to employee effort and performance
Employee dissatisfaction and demotivation if the company share price falls or fails to appreciate
Share purchase plans expose employees to considerable financial risk and loss of equity
Requires ‘open book’ management, which may expose management to greater scrutiny
May need to change management system to make it more participative and open
Costly to administer

7. Share option plans Fixed price option plans:
Previously confined to executives; now commonly available to managers and professionals
Employees granted an entitlement to purchase a specified number of restricted shares in the company at a specified (‘strike’) price at a specified future ‘exercise’ date (typically the third, fourth or fifth anniversary of the option grant date)
No ownership until option to buy is exercised
Strike price is typically the share price prevailing at the time the option is granted
Many option plans now have a ‘performance hurdle’ requirement

8. How do share option plans work?
At the grant date: 1 July 2012
The company share price is $10.00 per share
Option terms: each eligible employee may purchase up to 1,000 shares in the company at $10 per share no earlier than 1 July 2015 (= vesting date) and no later than 1 July 2017, at which time the option to buy lapses
Share purchase is self-funded
No performance hurdle restriction

9. How do share option plans work?
At the grant date: 1 July 2012
The employee does nothing in the short-term but decides to ‘wait and see’ what happens to the share price over the course of the following two years
Employee may either do nothing or exercise option to buy some or all of the 1,000 shares at $10 per share
If the employee thinks the company’s share price has peaked they may decide to exercise the full option and sell the 1,000 shares immediately at a pre-tax profit of $5 per share
If the employee expects a further rise in the share price, they may decide not to exercise the option just now (given that this will involve an opportunity cost and that the option to buy still has two years to run)
Price scenario 2: options ‘underwater’
Prevailing share price is $8.00
Price scenario 1: options ‘in the money’
Prevailing share price is $15.00

10. Employee share option plans
Advantages:
No up-front costs to the employee (though firm must expense against profit)
No absolute ‘downside’ risk to employees
Allows employees to defer liability for capital gains and income tax
Substitute for cash in start-ups and bull markets (e.g. Microsoft’s 10,000 millionaires)
Alignment with shareholder interests; ‘ownership’
Higher staff retention (‘golden handcuff’)

11. Employee share option plans
Disadvantages:
Encourage speculative behaviour; share ownership may be very short-term
Dilution
New option grants are a ‘cost’ to the organisation and should be ‘expensed’ against revenue

12. New option grant valuation
Current option holdings do constitute potential future income and an estimated ‘fair value’ should therefore be factored into annual total remuneration
New option grants are also a cost to the firm. Options granted generally have an expected cost to the firm of 30–40% of the fair market value
‘Present value’/grant date approach takes the projected future value of new option grants and discounts it to a present value in order to estimate the level of annual total remuneration
Most widely used approach to estimating present value is the Black-Scholes model, which takes account of:
Strike price
Projected price of an underlying security
Share price volatility
Risk-free rate of return
Expected dividend yield
Term of grant
Where a performance hurdle applies, the probability that this will be met

13. Recent variants on option plans
Premium priced options = strike price set above share price at grant date (= performance hurdle)
Zero exercise price options (ZEPOs) = deferred share grants with performance hurdles attached. Also called ‘performance shares’
‘Share appreciation rights’ – plans that reward for both share price movement and dividend stream

14. Recent variants on option plans
Source: John Egan Associates, Sydney. Reproduced with permission.

15. How does share ownership influence employee attitudes and behaviour?
Incentive effect:
Dividends and share price appreciation reinforce extrinsic motivation and task behaviour
Ownership effect:
Ownership mentality heightens organisational commitment, membership behaviour and organisational citizenship behaviour
Equity ownership reduces ‘them and us’ mentality and industrial conflict

16. How does share ownership influence employee attitudes and behaviour?
Involvement/participation effect
Involvement in decision-making may enhance feelings of trust, efficacy and job satisfaction, and consequently organisational citizenship behaviour
Participation heightens employee understanding of organisational finances, cf. ‘open book management’
Integration effect
May facilitate ‘shared fate’ mentality
Increased alignment between individual organisational goals may facilitate sharper performance focus, cf. ‘line of sight’
Increased sense of peer interdependence, which may lead to greater peer pressure and consequently stronger motivation to perform

17. Requirements for employee share plan effectiveness
Top management support for plan
Extensive communication about the nature of the plan and company finances
A high level of employee eligibility
A high proportion of employees who actually own shares
Eligibility for new hires as well as existing employees
Employees owning a high proportion of overall company equity
Participative development of the ESOP itself
Accompanied by a meaningful employee involvement program
Favourable economic climate and share market
Limited employee exposure to downside risk/loss