Building the business case is a vital part of any benefits strategy. Points to consider typically include costs and the potential return on investment. When looking at share schemes reduced staff turnover, improved employee loyalty and employer tax savings could form the basis of any business plan.
Article in full
When Virgin Mobile floated in July 2004, managers were surprised to find that potential investors expected the company to set up an employee share plan. And according to the company’s corporate affairs director, Steven Day, this tied in with what a Virgin Group company might be expected to have.
With the help of Lloyds TSB Registrars, the company set up a share incentive plan (Sip) and gave all its staff free shares worth around £750 each. It also offered options under a sharesave (also known as SAYE) plan.
Virgin Mobile is typical of a growing number of public companies which justify the costs of running a scheme against the potential benefits to the business.
“As a gift, [the free shares under the Sip scheme are] a small but nice thank you. We were keen for it to happen given the company culture,” says Day. While the business case for the sharesave plan was more tangible: “Staff see it as attractive and worth participating in and, from the company’s point of view, it engenders loyalty and dedication [while] providing a fair reward.”
Academics have taken almost as much interest in the return on investment of running share plans as investors and managers so their research forms the foundation of any business case. A 2001 survey by the London School of Economics found a 17% increase in productivity in British firms that gave their employees shares and a 12% increase where staff were given share options.
There is a similar link between share schemes and share price growth. The UK’s Employee Ownership Index (EOI), compiled by Equity Incentives, a firm that helps businesses set up share ownership schemes, tracks companies with more than 10% of their issued capital held by staff other than directors. This index has outperformed other major indices in the long term. For example, an investment of £100 in the EOI in 1992 would have been worth £349 at the end of June 2003; the same amount invested in the FTSE All-Share would have been worth £161.
Three things make up the cost of a share scheme: the initial set-up, the ongoing administrative cost, and the cost to the firm’s profit and loss account (P&L). Shareholders may also see any discount on the price of shares given to staff as a cost. The initial set-up costs can be fixed by competitive tendering between advisers providing all the likely costs are actually included and budgeted. Ongoing costs, meanwhile, depend very much on how many staff actually join a scheme. A good finance department should be able to run up a model based on historical leaver statistics and take-up of other benefits. Advisers can then add a level of detail and experience gained from other companies.
Much of the administration can be outsourced and, as you would expect, advisors argue against doing it in-house. “Talk to any adviser, and they’ll tell you horror stories of companies that set up their own administration with a spreadsheet and it quickly gets out of hand. It’s also time consuming, especially if you cock it up and you have to put it straight,” says Paul Stoddart, national new business manager at Halifax.
The good news is that “the NIC saving very much washes the face of launching the plan, in terms of both the administration and communication costs,” according to Justin Cooper, managing director of Capita Share Plan Services.
Depending on how and when a scheme is introduced, it can substitute for other elements in a remuneration package, form part of a pay review or coincide with a floatation or takeover, which can reduce its overall net cost. Because both Sips and sharesave schemes are tax-efficient they potentially offer more bang for the buck than cash salary.
Recent changes in the P&L treatment of stock options (including the future discounting of shares promised under a sharesave scheme) may have an indirect effect on share price if a company’s bottom line is affected. However, the impact will vary widely between organisations.
“You often find that companies offer share ownership to ensure that their overall remuneration is competitive with their peers but we don’t think this is the best way of embracing share ownership. Instead, start with what you want to achieve from the scheme and design it to deliver those objectives,” says Capita’s Cooper.
In recent years, Sips have been the biggest growth area. These are easier to tailor to different requirements and put shares into the hands of employees immediately. This means that staff have skin in the game from day one with the possibility of loss or gain. On the other hand, a sharesave scheme is extremely low risk for staff but relatively inflexible and arguably too remote to bring about a real change in employee behaviour.
“I see it as a triangle, with objectives at the top and the mix of risk and cost on the other corners,” says the Halifax’s Stoddart.
Research suggests that the benefits of share ownership are multiplied when schemes are matched with intensive staff communication and involvement in the business and with good HR practices. But on their own, share schemes cannot fix underlying problems in the relationship between management and staff. “It must go hand in hand with open management systems,” says Fred Hackworth, director of the Employee Share Ownership Centre.
Ultimately, the UK has the most tax-advantageous environment for share plans in the world and there is strong evidence that schemes can produce a real improvement in performance. Perhaps the most compelling argument for employee share schemes is the one advanced by Phil Ainsley, senior manager employee share plans business development at Lloyds TSB Registrars: “It is difficult to see how cash incentives would elicit the same real ownership behaviours.”
The business benefits of approved share schemes
• A tax-advantageous way to reward participating employees.
• Employer NIC and corporation tax savings can offset running costs.
• Can make staff feel and act more like owners, aligning their interests.
• Sips can give staff a taste of the risks and benefits of ownership.
• Focuses staff attention on P&L, share price and long-term prospects.
• Share-based golden handcuffs can reduce staff turnover.
• Can influence prospective employees’ views about employers.
• Over 50% of FTSE 350 firms operate a Sip, so it may be a requirement rather than incentive for attracting top recruits.
• Correlation between employee share ownership, productivity, and share performance.
Case study: Raymarine
When marine electronics manufacturer Raymarine floated in December 2004, it gave employees free shares in a share incentive plan (Sip). Steve Pearce, head of HR, explains that he wanted everybody in the business to understand the company’s profitability, how it drives the share price and how they could affect it. “If we were going to put in an sharesave scheme where they don’t actually own shares for a period of time, we’d get less impact. With a Sip, there’s more risk but [a greater] impact because people own shares and make the connection between profit and share price.”
Unlike the majority of Sips, Raymarine decided to give all the employees some free shares rather than offer matching shares as an incentive to employees who buy partnership shares out of their gross pay. “To do the matching shares the individual has to buy into the scheme. You’re only going to get 40%-60% of the employees buying partnership shares whereas with free shares everyone gets some,” says Pearce.
He is committed to getting the maximum benefit from the share schemes. “From the business point of view, we’re looking at making sure that everyone understands what profit is all about and [so] communicating targets becomes that much easier in future. It was also a thank you [to all our staff].”