ESOP Trends in India and USA

Overview-What is ESOP?

Employee Stock Ownership Plan (ESOP) is a compensation plan companies offer to employees, which involves granting them ESOP shares at a discounted price. ESOPs promote active employee participation and can provide tax benefits. They also serve as retirement savings and are used for succession planning and defense against takeovers.

A study from the nonprofit National Center for Employee Ownership highlights some impressive ESOP benefits. It shows that productivity improves by four to five percent in just the first year after adopting an ESOP. Additionally, companies with ESOPs experience 25 percent greater growth over a decade compared to similar companies with conventional ownership. Reflecting on the positive impact, a 2019 survey indicates that employees overwhelmingly express high satisfaction with their ESOPs, with many stating they would gladly undergo the transaction again. Moreover, proper ESOP accounting guarantees that the operation and implementation of ESOPs remain efficient, adding value to both the employees and the company.

ESOP Trends in the USA

The concept of ESOP in the USA was first developed and promoted by Louis O. Kelso, an economist and a corporate lawyer, in 1956 as a way to transition ownership of Peninsula Newspapers, Inc. from its two founders (both then in their 80s) to their chosen successors, the managers and employees. Kelso’s idea was to use an IRS tax-qualified plan as a tool for business succession as prior to this business owners just had two options, both leading to substantial loss, which was either to sell the business to a competitor or to sell a part of business to company’s key employees and let the company redeem the remaining. Before Kelso introduced the formal concept of ESOPs, there were many other companies including Sears Roebuck, J.C. Penny used ESOP shares to increase employee motivation and drive business success. 

In first few years after 1956,there were very few ESOP transactions as each transaction had to be reviewed by National Office of IRS(Internal Revenue Services). There were very few ESOP transactions after 1956 since each transaction had to be approved by the IRS To encourage bank lending to ESOPs, the law included a 50% exclusion from income tax for interest paid on ESOP loans.s National Office. An ESOP taxation incentive was introduced by the Tax Reform Act of 1984. The law included a 50% exclusion from income tax for interest paid on ESOP loans to incentivize bank lending to ESOPs.

In 2024, in the USA, ESOP plan is the most common way of employee ownership and more than 6300+ companies have ESOP (5800+ private companies and 456 public traded companies , holding assets of more than $2.1 trillions. On an average,259 ESOPs are created annually in the USA.

There are 14 million+ ESOP participants overall out of which 10.7 million are accounted to be active participants (currently employed) and 4 million as inactive ones(ex-employees).

Around 8% of the 14 million participants are in the private sector workforce,50% of which are held by private ESOP companies which specialize in manufacturing industries (21%), Technical services/professional industries (19%) and in construction industries (15%).

ESOPs are on the rise as businesses across the USA have recognized the benefits of employee ownership and other advantages of ESOP. According to NCEO, the largest ESOP-owned company in the USA is Publix Super Markets with 100% ESOP.

ESOP Trends in India

In India, the concept of ESOP was brought to public disclosure by Infosys in the 1990s before the company was even listed on the stock exchange. It created a large number of ESOP rupee millionaires and billionaires. The Income Tax laws at that time made ESOPs taxation even more appealing as no taxes were levied at the time of employees either exercising their stock options or when they sold it. This made ESOP shares more valuable, doubling their worth compared to traditional salaries making it a more sought-after form of compensation. 

India adopted ESOP plan to create a feeling of belongingness in the employees as high competition among laborers led to no acknowledgment of employee’s needs and demands which further led to employees doing work just to meet their basic daily needs and not for passion or achievement. Private companies in India can adopt ESOP by following the Companies Act,2013[Sec 2(37)] and the Companies (Share Capital and Debentures) Rules of 2014.As for public companies and listed companies, they should observe the SEBI’s ESOP guidelines. ESOPs have positively impacted the Indian economy, benefiting both employers and employees in the long term by boosting motivation, productivity, and financial rewards.

In the FY 2023-24, according to the analysis of the VC Circles, 32 Indian startups have spent close to ₹3,000 crore, or about $440 million, to buy back employee stock options (ESOPs). Flipkart, a leading e-commerce giant has the largest ESOP pool in India worth over

$1 billion allocated to employees. Other famous listed as well as unlisted startups such as Zomato, OYO, Paytm, Sharechat etc. contribute significantly to the ESOP pool in India.

Conclusion

ESOPs provide a diverse range of benefits. It enhances a company's financial performance, improves employee engagement and retention level, facilitates ownership transitions, and offers significant tax advantages through ESOP taxation. Accurate ESOP accounting ensures that these ESOP plans are handled effectively, keeping track of ESOP shares and ensuring compliance with regulations. In both the USA and India, companies are increasingly recognizing the benefits of ESOPs as assets for long-term growth and stability.