Matthew Stibbe discovers the potential stream of companies turning away from option-based schemes in the wake of new accounting rules is currently just a trickle.
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New guidelines for the treatment of share-based payments, including employee share schemes, were published by the International Accounting Standards Board (IASB) in February last year. The rules, known as IFRS 2, came into effect on 1 January this year for public companies and will begin to affect non-listed firms from January 2006.
The change means that companies must now include the cost of options in their profit and loss statements. Besides presenting accounting challenges, such as the proper pricing of options, many feared that this would mean a wholesale retreat from option-based schemes, including sharesave and approved share option plans.
Ten months later, the front has not collapsed. No believer has abandoned the concept of all-employee share participation. But there hasn’t been a universal reaffirmation either. Wait and see is still the most common response. Justin Cooper, head of share plans at Capita, says: "Anecdotally, I would say less than a third of our companies have either already taken action or are taking action."
So far, there has been a modest move away from options towards whole share incentives; typically shifting from sharesave to share incentive plans (Sips). A handful of companies have revised the discount on their sharesave scheme, but the majority are waiting to see what their peers do or waiting for upcoming benefit reviews to evaluate their options. One fear is that some companies are simply ignoring the problem.
HBOS changed from an option scheme to a whole share scheme, with the accounting changes acting as a contributory but not a decisive factor in the switch. Its previous scheme offered options worth 20% of salary for all but the top fifty employees of the company. With the stock market struggling, the share price didn’t go up and there wasn’t a huge amount of value being generated for employees.
This fact coupled with the new accounting standards triggered a review last year. The company replaced its existing share scheme with a Sip which was announced just before Christmas. Its 67,000 UK employees are entitled to a grant of shares worth 5% of their salary subject to a minimum of £500 and a cap.
John Chilman, head of reward at HBOS, says: "In terms of the profit and loss hit, we made it basically cost neutral. It wasn’t a cost saving exercise. Here, at least the cost, benefit and value are directly linked. With whole shares you know the charge on day one. It reduces the complexity."
In other organisations, meanwhile, there’s more activity at the top. Julian Foster, head of specialist services at Halifax Share Services, says: "We are seeing most companies spending their time looking at the implications for their executive plans."
Overall, however, it typically comes down to effectiveness. Leslie Moss, an associate at Hewitt, believes there is still a major misconception about IFRS 2: that it increases the cost of share plans. In reality, there is no cash cost to the P&L changes. "I think people are reading past the presentational aspects. People recognise that these liabilities were there already," he explains. Consequently, he is optimistic that employers will not see a series of misjudgements of poor decisions.
When asked about his verdict on the French Revolution, Chairman Mao replied that "it is still too soon to tell". And ten months in, the same seems to be true of the impact of IFRS 2.
What is IFRS 2?
The new standard means that charges will be made to a company’s profit and loss (P&L) statement for the fair market value of share-based payments, including staff option schemes such as sharesave, enterprise management initiative schemes, approved share option plans and unapproved option schemes.
The intention is make these costs more transparent. Critics argue that the P&L account is not the right place to record transactions between shareholders. However, many large US companies had already begun to account for options and analysts had already begun to allow for them.
The rules applied to public companies from the beginning of January this year and to everyone else from 1 January 2006. The P&L line item is likely to be accompanied by a supplement with more details, although this is not mandatory.
Calculating the fair market value of shares is straightforward but pricing options is more of an art than a science, and there can be uncertainties when staff move from one scheme to another.