One of the popular objectives of stock option plans has been
performance payment. The linkage has been most discernible in the case of senior
management. It is reported that in some of the companies in USA, the payment for
chief executives through stock options is over three times that of their normal
salary. The trend has been to pay senior executives and critical employees for
their performance increasingly through stocks. This move helps in several ways.
Firstly, the cash out-flow for the company would be
lower as the stock options would not entail immediate cash payments.
The company pays in stock options or warrants for which there is no
immediate cost to the company. In fact, eventually, it is the market,
which pays for the stock when the employee sells the shares. (The only
issue is the contingency of the company having to buy-back the options
/ shares in future at the fair market value.) However, if there is any
concession from the fair market value, the same needs to be reckoned
as an expense in the profit & loss accounts – this is as per the SEBI
guidelines of June ‘99.
Secondly, hefty cash payments would create a feeling of
extraordinary differentials between the lowest and the top – in
fact, in the Western countries, employees have been vociferous
about the growing differentials. The norm that has been accepted
is that the ratio should be about 1 : 8 between the lowest paid
and the highest. Some experts had even advocated a ratio of 1 :
5 as desirable in the long run.
However, the nineties have witnessed a reverse trend,
justified or otherwise. The new thinking is that there need not be any caps to
the differentials based on ill-conceived egalitarianism. Instead the need has
been recognized for incentivizing top management on the basis of evident
contribution to profits. Though huge bonuses to the top management may be
justified, they create a sense of relative deprivation among the other
employees. Consequently, some organizations have devised a way of awarding
stock options to employee as deferred pay in kind and thus lowering the
visible component of bonuses. However, the actual quantum of benefit can be
realized by the employees only on selling the stock in the market and is
subject to the developments at that time.
Thirdly, such payments in stock reinforce the stake of the employee in the
performance of the company and thus may reduce the problems associated with the
principal-agent problems.
Fourthly, the employee has better control over the choices he may make on when
to en-cash, the size of the portfolio to be en-cashed and the like after
reckoning the tax liabilities and the market movements for the stock prices.
Fifthly, the options granted for the main purpose of performance reward will
achieve other objectives as well – these additional objectives could be those
related to retention (as a golden hand-cuff in case there is a service lock-in)
and commitment.
