What Makes ESOPs a Hit or Miss?

Written By:
Team Qapita
September 15, 2023

Employee stock ownership plans (ESOPs), also known as equity compensation plans, are prevalent worldwide to give employees ownership in the companies they work for. With the recent wave of startups, ESOPs are also becoming increasingly popular in India. They can be used to achieve a variety of goals, such as retaining talent, rewarding loyalty, improving performance, and reducing the cash component of employee compensation.  

However, implementing ESOP does not automatically guarantee accomplishing these targeted outcomes. There are important factors that determine whether the ESOP implementation in an organization ultimately turns out to be a hit or a miss. In this article we will discuss some of these points in detail.  

Key Points to Remember

  1. Employees’ faith in the philosophy of the organization: ESOP benefits are proportional to the growth of the company. ESOPs are only valuable if the company grows, and employees believe in the company's vision. When the employees do not believe in the philosophy of the organization, the growth of the company is obstructed resulting in no addition to ESOP value. Therefore, it is an inter-dependent process where the employers need to instill faith in employees about the growth trajectory and employees need to have faith in the organization's vision and the change that it is bringing.  
  1. Quantum of Benefit being granted as ESOPs: While granting ESOPs, there could be a failure to evaluate the quantum of benefit to offer. In absence of an optimal benefit offered, employees tend to get lured by lucrative compensation packages from other companies, which outweigh the ESOPs offered in the current organization. A detailed study of the industry compensation practices, current compensation w.r.t criticality of resources and time horizon of the ESOP plan, could help in determining the adequate benefit to be offered as ESOPs.
  1. Fairness of management and commitment towards employees: Many companies promise ESOPs to their employees, but then delay implementing them or granting the options. This can undermine the effectiveness of ESOPs, as it can make employees feel like they are not being treated fairly. Management should take steps to ensure that ESOPs are implemented and granted promptly, and that employees have the opportunity to exercise their options at a fair and reasonable valuation.
  1. Effective Communication: ESOPs are relatively complex and difficult to understand component of the compensation plan. It mandates simple, effective and regular communication by the management to the employees. Success of ESOP program largely depends on how well employees understand the modalities of ESOP, valuation methodology, current valuation, the growth forecasts, the value creation in future.
  1. Market Conditions: Occasionally, the prevailing economic conditions and industry sentiments could also have a significant bearing on the success or failure of ESOPs for an organization. When the Industry or economic situation is not very encouraging, Employees tend to lose faith in the ESOPs being granted (either in lieu of current pay cuts or to provide rewards of future appreciation). The value of ESOPs granted earlier might also erode because of the recession and render them underwater. Management should consider measures to modify the Plan to reinstate value in ESOPs, for e.g., re-pricing and extending of the exercise period.
  1. Matching of Objectives and Plan Design: It is necessary for an organization to identify and prioritize the objectives it would like to achieve by implementing ESOPs. ESOPs lose ground in case of a mismatch in the expectations of Management or Employees and the ESOP Design. Before designing the plan, each Company should analyze the alternatives and adopt the best structure that would work for its unique ecology.

Bottom Line:

Organizations should lay the foundations of their ESOP program after consideration of the above points, to ensure greater chances of success. Instilling faith in the ESOP process is a two-way process in which both employers and employees have to contribute their bit. Keeping these in mind and designing the right ESOPs will help to make the compensation process smooth, transparent and easy to understand for all.  

Team Qapita

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