Why are ESOPs Effective?

Overview

ESOP plan, a compensation scheme complementary to the salary, emerges as a crucial tool to develop a “Business Owner” mindset in the senior personnel of the company. ESOP fosters an innovation-based culture and plays a significant role in driving long-term value for the shareholders. ESOPs are used by many companies including start-ups like DeHaat, and Classplus and established giants like Infosys, Wipro, and Axis Bank. 

There are two-fold ESOP advantage system where employees gain from getting the ESOP stocks at lower prices than the market value and at the same time, it helps to retain the key employees of the company and foster a sense of loyalty. Hence, it acts as a binding force between the employees and the organization. 

What are the Benefits to Employees of getting ESOP as a compensation?

After seeing ESOP in your CTC, you will wonder why an ESOP plan is better than a higher salary? Why shouldn’t you join a company which is offering you a higher salary instead of some promise on a paper to let you buy some stocks in future from the company itself. Here we answer this question for you. ESOPs can offer many advantages to the employees such as below:

1. Asset accumulation: ESOPs can help you to accumulate wealth creating assets in your portfolio of investments. By exercising your ESOP shares and acquiring the stocks of the company, you can accumulate stocks which will increase in value as the company expands its operations and grows its revenue and profits.
2. Income generating assets: ESOP plan can help you accumulate long-term income-generating assets. By exercising your ESOP plan and acquiring a portfolio of stocks of the company you work for, you can benefit from the dividends that will be paid to you as a shareholder of the company. As the profits of the company grow, the dividends paid to you will also increase. 
3. Sense of ownership: ESOPs bring a sense of ownership to the employees. The growth of the value of ESOP shares is directly linked with the growth of ESOP. The result and the outcome brought in by the employees to the organization add up to the profitability of the company. This, in turn, increases the value ESOP shares. Thus, employees assume that the growth of the company is linked to the growth of ESOPs, and an ownership mindset to work through thick and thin for the company lights us in the minds of the employees. Thus, ESOPs foster a sense of ownership in the employees. 

• Retirement Plans: The financial security after retirement is always a matter of concern for any employee. ESOP Share provides a way to overcome financial insecurity at the time of retirement. The stocks can be sold and converted into cash, thus, making the employee financially secure. 

• Employee Engagement: ESOPs empower the employees to have a say in the decision-making process. The employee feels empowered and motivated to contribute effectively to the decision-making process. The employee is engaged in the progress of the company and thus improves engagement. 

• Monetary Gain: Stocks are offered to employees at low prices under the ESOP plan. This means that if the employee showed willingness to purchase the stock, he would have purchased the stock at much higher prices but through ESOP, he gets the stock at discounted prices. Thus, ESOP shares also provide monetary gain at the time of exercise of stock option.

Benefit to Employers

Employees are the backbone of any organization and maintaining a satisfied workforce is crucial for any organization be it a start-up or a multinational giant. Companies with ESOP plan enjoy numerous benefits which are mentioned below: 

1. Ownership Transition/ Legacy Preservation: Many entrepreneurs pour their blood, sweat, and tears to build their company. They are connected to the history, values, and vision of the company. Often they might feel ambiguous about the future decision-maker for their company. Thus, ESOP, in a way, transforms them from CEO to member of the Board of Directors and also being the decision maker during retirement.
2. Competitive edge in the industry: Employees today need much more than just a salary. By offering ESOP plans as an addition to base pay, companies create and maintain their competitiveness in the entire industry. These kinds of compensatory packages tempt other prospective and talented employees to join the organization and add value to it. Thus, ESOP shares increase the competitiveness of the company both in terms of talented employees and output.
3. Positive Influence: A study has shown that ESOP positively influences corporate culture regardless of the company's size and management. The growth of ESOP issuing companies is estimated to be 3 to 4 times that of non-issuing companies. ESOPs ignite optimism and enthusiasm in the employees once ESOPs are issued. 

• Low Attrition Rates: Companies issuing ESOPs generally experience lower attrition rates than non-ESOP issuing companies. This is generally due to the monetary benefit that employees are at risk of losing, in case of voluntary termination of employment. As per our research, ESOP companies' attrition rates are around 10% while it is around 26% for non-ESOP companies. 

• Tax Advantage: The benefit of tax reduction that the company enjoys comes into play through the issue of ESOP shares. This means that companies with ESOP plans incur less tax liability because the price at which the company offers ESOPs to employees is added to the cost of the company and thus, the tax liability of the company is reduced significantly.

Conclusion

ESOPs are a win-win situation for both employers and employees. While employees feel empowered and aligned with the goals and interests of the organization, employers use it as a tool to retain the top talent in the organization and take an edge ahead of other players in the industry. Our research has shown that ESOP issuing companies generally grow faster than non-ESOP companies. Through efficient ESOP accounting, these shares can be properly tracked, and ESOP taxation advantages make them financially advantageous.

Many industrial giants like Zomato, Swiggy, and Nykaa have issued ESOP plans, and these companies' have shown tremendous growth in their operations and revenues. ESOPs are a good-to-go path for companies to get double benefits. Hence, ESOPs are an effective way for the betterment of the company and its employees.