Retain talent by granting stock incentives,Preeti Sharma, Senior Tax Professional, Ernst & Young ,Oct 12, 2012

http://articles.economictimes.indiatimes.com/2012-10-12/news/34412977_1_stock-options-options-vest-employees

In this period of recession, when the profit graph is falling down and cash flow is one of the challenges for the companies, the biggest test for an employer is to retain star performers without shredding cash from the pocket.

As talent management leaders are inventing new ways to face this challenge, we re-walk you through the age-old carrot 'stock options' as a tool for talent retention. Many companies use stock option plan as an effective tool not only for retention but also to compensate the existing employees and to attract new talent from the market.Stock option plan is a contract between the employer and the employee which gives the employee a right to purchase company's shares at some time in the future at a discounted price. Employees are eligible to exercise their right to buy shares, after the options are vested.

Ideally, the market value of the shares would increase during the vesting period, so that employees are able to purchase shares at a significant discount. Upon exercise of options, the employees can either hold the shares or sell them in the market or back to the company/promoters if the shares are not listed.

The effectiveness of stock options in increasing employee loyalty and commitment to the company cannot be ignored. However, we still avoid using them in our businesses. Their high administrative cost and the fear of dilution of your equity is what perhaps overshadow the benefits they offer.

But isn't it cost effective to administer a plan rather paying the cash upfront? Whether administrative cost of the plan surpasses the benefit of retention of the employees? Is there a way to share the growth of the company with employees without diluting your equity under a stock option plan? Let's find out.

While, the commonly used techniques of remunerating employees have to be funded by significant cash outflows, the first reason why stock options find favour over all of these techniques is the fact that grant of stock options does not require cash outflow for the employer.

Secondly, stock options are a long-term form of remuneration, as the vesting schedule ensures that the employees work for a specific length of time before they encash the options. Besides this, the vesting schedule can be re-engineered keeping the company's objectives in mind. Most companies have schemes wherein options vest annually over a few years, say about three to four years. Another innovative mechanism may be an annual grant of stock options with overlapping vesting periods. With every new grant of options, the employee's stake magnifies, thus ensuring his longevity in the company.

Next, the vesting conditions inbuilt in the stock option schemes can help the company align employee's performance with its own objectives. Vesting conditions could include a target turnover, market performance of the share, or any other condition that the company finds reasonable as well as attractive. Thus, stock options satisfy the twin objectives of employee retention along with improved company performance.

Companies can smartly work around with the variety of stock-based incentive plans available nowadays without allotting actual shares to the employees. Eg. Stock appreciation rights give employees, the monetary equivalent of increase in share price over a specified time. Cash settled stock based plans ensure that the employee grows with the growth of the company and at the same time promoter is not required to worry about dilution.