Turning Employees Into Partners

Turning Employees Into Partners

Owners and managers of businesses are inherently at odds with one another. For example, the former aim to keep prices as low as possible, while the latter want to keep earning enormous incomes as long as they are in power (who knows what may happen tomorrow). While some publicly traded companies aim to optimize their stock value in the short term, others may have a longer-term perspective. In the United States, stockholders prioritize the growth of their equities, which is determined by quarterly and annual profit data. This reduces the amount of space available for infrastructure expansion, research and development, and technological innovation. According to the hypothesis, employees who also own shares will be shielded from these toxic tensions, which can occasionally bankrupt businesses and often cause them to deteriorate technologically and financially. A second article will be dedicated to the quite different subject of whether reality leaves up to theory.

The right to buy (or sell; however, this is not relevant in our situation) a stock at a certain price (the strike price) on or before a certain date is known as a stock option. For private companies, stock options are either not traded, or they are traded on a stock exchange for public companies whose shares are traded there.

Stock options are useful for a variety of purposes. In the case of put options, which let you sell your stocks at a predetermined price, they can be used as a hedge, or insurance, against stock positions. They are also popular investments and speculative vehicles in many Western markets. Huge gains can be made with a very small initial investment and very little risk (one can lose only the money used to purchase the option).

Astute entrepreneurs and shareholders started using stock options as a means of encouraging their employees to work exclusively for the company. Typically, top managers who were regarded as indispensable were the only ones eligible for such benefits. Later, when employers came to understand that their most valuable resource was their workforce, all employees started to benefit from the same opportunities. An employee who participates in an incentive stock option program receives from the company, as part of his remuneration package, the option to buy the company's shares for a predetermined number of years at a price that is either at or below the market price at the time the option was granted. The primary portion of top Fortune 500 managers' compensation in the USA currently comes from profits from these types of options, and even in more conservative Europe, this practice is becoming more common.

An organized program that permits employees of a company to purchase its shares is called a stock option plan. In order to encourage employees to invest in shares, the employer will occasionally provide them with subsidized loans or even match their purchases, giving the employee a free share for each share they acquire. Employees are frequently given the option to purchase business stock at a discount, which results in an instant profit. Employees may reinvest dividends on their holdings of company shares (some companies automatically do this for them, either without or with a reduction in brokerage charges). Many businesses provide wage "set-aside" plans, whereby workers routinely set aside a portion of their pay to buy company stock at the going rate. The Employee Stock Ownership Plan (ESOP), another well-known format, allows employees to gradually amass shares and perhaps take over the company.

Let's examine many of these schemes in more detail:

Ronald Reagan started it all. The Economic Recovery Tax Act (ERTA - 1981), which his administration enacted in Congress, defined certain types of stock options (known as "qualifying options") to be tax-free on the date of award and the date of exercise. Preferential (lower rate) capital gains tax was applied to profits on shares that were sold after being held for at least two years from the date of grant or one year after being transferred to an employee. Thus, the "Qualifying Stock Option"—a brand-new category of stock options—was created. Legally speaking, this type of option was seen as a privilege given to a corporate employee, enabling him to buy shares of the company's capital stock at a discounted price (subject to the Internal Revenue law, which is the American income tax code). In order to be eligible, the option plan needs to be approved by the shareholders and the options themselves need to be non-transferable, meaning they can't be sold privately or on the stock exchange for a set amount of time. Further requirements state that the employee who receives the stock options (the grantee) may not own stock representing more than 10% of the company's voting power unless the option price equals 110% of the market price and that the option is not exercisable for more than five years after it is granted. The exercise price also cannot be less than the market price of the shares at the time the options were issued. At neither the time of the grant nor the exercise, when the employee converts the option into shares (which he can sell at a profit on the stock exchange), income tax is not due by the employee. Another option with a lower exercise price may be granted if the market price drops below the option price. The value of the stock covered by options that can be exercised in any given calendar year is capped at $100,000 USD per employee.

The establishment of Employee Stock Ownership Plans (ESOPs) was prompted by this law, which was intended to strengthen the bonds between employees and their employers and to increase stock ownership. These are initiatives that motivate staff members to buy business stock. Workers are able to take part in the company's management. They can even assume control in specific circumstances, such as when the business requires rescue (without sacrificing their rights). Workers may grant ownership privileges in exchange for pay reductions or other concessions on work rules, but only in the event that doing so puts the business in danger of closure ("marginal facility").

What percentage and how should a business give its employees in stock?

Other than the need that ownership and control not be transferred, there are no rules. Several techniques:



Employees bid on packages of shares or options in open tender when the corporation offers them in varying sizes.

Employees can exchange shares amongst themselves when the firm sells them to them on an equal basis (any senior management member, for example, is entitled to purchase an equal number of shares).

The right to issue shares to employees or to a particular group of employees may be granted by the company to one or more of its current shareholders.



When an employee exercises his or her right and purchases shares, the proceeds from the conversion of the stock options often go to the business. The business records an amount of shares in its records big enough to satisfy the demand that all of the stock options will create. To satisfy such a demand, the corporation may need to issue additional shares. The stock options are rarely converted into shares that other owners already own.

We will discuss the (surprise) questionable effectiveness of stock option schemes in one of our next posts.

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