The main aim of setting up share schemes is to make employees think twice about quitting, says Roger Carter
Share schemes are far too important to be lead by the human resources department,” says Malcolm Hurlston, chair of the Employee Share Ownership Centre. It impacts on employees, shareholders and investors and therefore, he adds: “Finance directors need to be involved in designing and setting up schemes, [and thus gauging] return on investment.”
Assessing the costs depends on whether the scheme is giving away shares, or awarding options. Shares come at the cost of diluting the holdings of existing shareholders, whereas options have recently started attracting an accounting charge.
Hurlston says: “It’s an accounting cost rather than a cash cost, so it’s going to be up to the finance director to advise on whether the hit is worth taking.” If the cost is too high, employers do not have to run the scheme. Indeed, there was a wave of cancellations when the accounting rules first came in, and the number of sharesave schemes according to HMRC has fallen from 1,110 in the year 2000-2001 to 780 in 2005-2006. But they remain the most popular type of all employee share scheme.
Some have chosen instead to alter schemes to make them cheaper. For sharesave, for example, Peter Leach, a director of scheme specialists Killik Employee Share Services, says: “Some companies have reduced the discount they are offering.”
Sue Bartlett, a senor consultant in the executive compensation division of consulting firm Watson Wyatt, adds: “A lot of companies used to offer options at the maximum 20% discount to today’s share price. Now they have cut or removed the discount.”
Statistics from share promotion organisation IFS ProShare show that last year 3% reduced the discount and 0.5% dropped it altogether. For share incentive plans (Sips) meanwhile, Leach says many schemes have changed the basis on which they offer matching shares: “Two-for-one offers may reduce to one-for-ones.”
But the role of the finance director isn’t just to cut costs, they must also weigh these costs against the potential benefits of a scheme, to understand whether it’s worth offering at all.
Some benefits are fairly clear, such as the role of share schemes in recruitment, particularly when it comes to executives. Bartlett says: “A lot is driven by the need to offer [competitive] remuneration plans for senior people.”
Mike Landon, a principal at consultants Mercer agrees: “Quite often a company will put in a plan because a competitor has an identical or similar plan, or because they want to offer something better, to boost recruitment and retention.”
The retention benefits are also self-evident. Bartlett points out: “The main objective for many companies is that they want employees to have something that’s at risk if they leave the firm, to make them think twice about leaving.”
Other benefits are less tangible, such as the idea that schemes align staff with company performance. This is a commonly-held belief.” Hurlston adds: “It helps align the interest of shareholders and employees so everyone is working towards the same thing.”
However, it’s difficult to prove. Landon points out: “There is evidence to suggest that companies with share plans perform better in terms of return on capital, and total shareholder return.”
Phil Hall, head of media and public affairs at IFS ProShare says: “The UK Employee Ownership Index (EOI) measured the relative share price performance of UK quoted companies with significant levels of employee share ownership and demonstrated that an investment of £100 in the EOI in 1992 would, at the end of June 2003, have been worth £349; the same amount invested in the FTSE All-Share would have been worth just £161. However, as Landon points out: “It’s very difficult to establish causation. A generally well-run company may have a share plan and performance may be better. It’s not necessarily down to the plan.”
Another common assertion is that schemes can act as corporate glue, especially during mergers and acquisitions. Bartlett says: “Some companies say it gives them a reason to talk to employees with a positive message.” Again, however, evidence for this effect is mostly anecdotal.
Other employers run schemes as a method of wealth creation for staff. This is more straightforward to prove, because when a share price is on the march it benefits all members. Since last year’s Budget, changes to capital gains tax have made schemes even more beneficial, providing shares have not been held for more than 10 years. And once a scheme has matured, shares can even be transferred into a pension, receiving a second round of tax benefits, and helping employees save for the long term.
However, this depends on the performance of shares. Hurlston accepts: “Schemes lose some of the incentive effect where shares have gone down, and where staff expect [further falls].”
Volatility in the markets has encouraged employers to favour granting shares rather than options. Landon explains: “There has been a move away from options to award shares, so if the price drops they will still get some value from the scheme.”
The return on executive schemes is easier to quantify, as it’s far more common to have a performance element to the scheme.
Designed correctly, they can be effective at pushing certain sorts of performance. Landon explains: “Some may take the standard [performance measure] of total shareholder return. Others may be careful to ensure the plans are aligned to strategy. In some circumstances, for example, the firm needs to grow, so there may be an emphasis in increasing turnover rather than short-term profit. In other cases there may be cash flow [aims].”
Landon also highlights that using share price as a measure of success in a falling market may not be effective: “The share price may be compared to a group of competitor companies.”
The performance criteria make the return on a share scheme far more measurable. If the scheme is too costly for the return it generates, employers can trim costs. Bartlett explains: “One way of cutting the cost is to grant options to fewer people. Whereas before it might have been for the top 20% of employees, now it may only be the top 15% or 10% or only the board.”
The performance measures within executive schemes mean they can be assessed fairly rigorously. Unfortunately, it’s harder to assess the return of an all employee scheme. So weighing up the costs and the benefits requires some leaps of faith. Finance directors must make a decision on whether they believe the scheme delivers the less tangible benefits the experts claim, and only then can they decide whether a scheme is worth the cost. However, the simple fact that employees must put their own hands in their pockets to fund these schemes, and five million of them do, demonstrates the value that workers see in them.
• Share schemes impact on employees, shareholders and investors. Therefore finance directors need to be involved in designing and setting up schemes, so they can be sure they are getting a return on their investment.
• Shares come at the cost of diluting the holdings of existing shareholders, whereas options attract an accounting charge.
• The main objective of offering schemes is to make staff think twice about leaving.
• There is evidence to suggest that companies with share plans perform better in terms of return on capital, and total shareholder return.
• The most common measure for executive share plans is total shareholder return, which aligns executives to the return shareholders get.
Common Share Schemes Explained
Share incentive plan (Sip)
There are three parts to the plan, and a company may even operate all three.
1 Partnership shares give employees the right to buy shares tax-efficiently.
2 Matching shares are given for each partnership share bought.
3 Free shares are simply granted. Sticking to the rules renders tax gains.
Sharesave or save-as-you-earn (SAYE)
Employees are given the right to buy a share at a fixed price at some time in the future. This is known as an option. In the interim they put a fixed sum away every month in a savings scheme, subject to a maximum of £250 a month. At the given date, if the share price has risen they can use the money to buy the shares, for an immediate profit. If the share price has fallen they can choose to take the cash back – with a bonus. There is no tax on the grant of the option and there will normally be no tax or national insurance when the option is exercised.
Company share option plan (Csop)
These give employees the right to buy a certain number of company shares at a fixed price at some point in the future. Like the Sip and sharesave, this is an approved option scheme, so is subject to Revenue rules and is tax-efficient.
Enterprise management incentive (EMI)
Share options worth up to £10,000 can be granted to employees in any qualifying firm, tax-free. To qualify, it must not have assets over £30m, and as of next month, has fewer than 250 staff.
This is an unapproved scheme, with no tax advantages. But the firm has flexibility in setting performance criteria and deciding the size of the award.
Source: HM Revenue & Customs, June 2007
(NB The totals aren’t simply a sum of their constituents because some companies offer more than one type of scheme)