It is a stormy time for share schemes, so companies might need a change of tack, says Sarah Coles.
To create a buzz around a company share scheme, it helps to have two things: a buoyant stockmarket and a booming economy. At the moment, the UK is failing on both counts. Recent stockmarket turmoil resulted in the FTSE-100 plunging to a three-year-low below the 5,000 mark at one point last month, and the UK economy officially ground to a halt in the three months to June this year.
In these circumstances, employees’ faith in their company share schemes can easily be undermined. For one thing, falling share prices are likely to have rendered current sharesave options worthless. Sue Bartlett, senior executive pay consultant at Watson Wyatt, says: “Share options are worthless if they have fallen below the exercise price, and current schemes are almost all underwater.”
Share purchase plans have also been hit by declining share prices. Peter Leach, a director of Killik Employee Share Services, says: “With share incentive plans (Sips), people have lost real money on a lot of plans.”
This does not bode well for future offers to join company share schemes. Bartlett points out: “With an all-employee share scheme, the number that take it up tends to depend on the performance of the scheme that matured most recently. It is not logical, but it’s human nature.”
Even staff in executive long-term incentive plans (L-tips), which tend to pay out shares at no cost to the employee, could find their expected gains are hit as the economic downturn puts targets out of reach. “With an L-tip or performance share plan, it’s a question of whether they will hit the performance criteria in this environment,” says Bartlett.
In addition, those employees who are not far off reaching their targets, may face disappointment if a scheme is linked to the share price. “When the share price is erratic and has little to do with the actual performance of the company, it is easy to lose faith in a performance-related scheme linked to the share price,” she adds.
There are also concerns for employers. If employees fail to realise the gains they expect from their schemes, the employer is in danger of losing the staff who can help a company through this difficult time, because failing plans lose the power to retain talent. Also, if performance-related plans fail to drive the performance of key employees, overall company results will suffer.
Employers with schemes that are failing can try and make them work better. They have a number of choices. Firstly, they can change the schemes on offer to make them more attractive. With sharesave, they can widen the discount to as much as 20%, and with a Sip they can offer more matching shares or free shares. The latter is not proving a popular option in the current economic climate, says Leach. “We haven’t seen more matching or free shares through a Sip,” says Leach. “While this may make schemes more attractive, it would also cost companies more, and one of the reasons the share price is falling may be that the company is not doing well, so it will not want to take on more cost in the share scheme,” he adds.
Changes to performance-related schemes are more likely, says Bartlett. “Companies are starting to look at changing performance conditions. So, for example, if there is an earnings-per-share criterion, it may be recalibrated. Other performance criteria typically include total shareholder return. But companies that have previously used this may turn to other metrics they have more control over.”
Deborah Broom, business development manager at Capita Share Plan Services, suggests companies could consider introducing a measurement against the peer group instead of a payout based on a fixed target being reached.
However, employers should look further than simply tweaking a share scheme to ensure that it continues to deliver value.
Sophie Black, a director in Ernst & Young’s performance and reward practice, points out: “Companies are looking to get full value for their schemes in this environment. It’s costing them, so they need employees to value it. This may mean communicating the particular benefits of each scheme in the current environment. For example, in the case of sharesave, employers could emphasise the fact that it is risk-free.”
In fact, the launch of a sharesave or Sip during this difficult period could turn out be beneficial for staff in the long term. Bartlett explains: “The future rewards may be bigger if a scheme is launched in a downturn. If the option is granted when the share price is low, there is a good chance it will recover during the period the scheme runs for, so participants stand to gain more. Likewise, with a Sip, employees are getting more shares for their money at the moment.”
Communicating a share scheme and the background against which it is offered to staff must be handled carefully so that employers do not cross the line between providing financial education and advice. Only businesses authorised by the Financial Services Authority can provide advice. For this reason, many employers stick to providing simple factsheets, while others host presentations where employees can ask more detailed questions about share performance and the economic environment.
Broom says: “On the whole, word of mouth is more effective, so we would [also] suggest having local champions who are able to talk to people about it being a good time to get involved.”
But share scheme communication should not be considered in isolation because the perk is a key part of the benefits package and helps to retain staff, says Black. “Share plans are being communicated as part of the whole package. Employees should be asking, if they have £250 to put away, should it be in a share plan or a pension contribution, or should they look to pay it into a share plan which can then go into the pension, saving them even more tax. It’s about wealth creation, and maximising what employees are getting.”
Creative employers are even deciding to maximise the power of shares by offering them instead of cash bonuses to reward top-performing staff. This helps them fill a hole in the overall benefits package at a time when cash may be tight.
Black explains: “We are seeing share plans being used as bonus replacements this year. The bonus pool is not going to deliver, so shares help to retain executives and key performers. Everyone wants cash — the company, the employee and the shareholder. Share plans stretch resources. It’s attractive for employers because there is no cash outlay, and the accounting charge is lower than the charge for cash.”
Employers should be aware that a poor economic environment may lead to employees deciding to pull out of a sharesave scheme which is underwater and switch to a new one with a more favourable option price.
Peter Leach, a director of Killik Employee Share Services, says: “It means starting from scratch and waiting three or five years for the payout, but employees will get the option at a lower price, which means it is less likely to be underwater when it matures.” Unfortunately, this can create headaches for employers, not just because of the administration, but also because of the charges. Sophie Black, a director in Ernst & Young’s performance and reward practice, explains: “Companies are keen not to encourage it because it gets the accounting hit twice: the original option attracts a full charge, as does the other option.” But the good news for employers, says Deborah Broom, business development manager at Capita Share Plan Services, is that “most employees are just carrying on”.