Firms offer employees a share of the action

Suddenly, share options are in the news, as companies look at ways of giving their employees and managers a piece of the action. For some years now we have been hearing of top executives benefiting handsomely. But employees are now starting to benefit too.

The secretary-general of the Department of Public Enterprise, Mr John Loughrey, has said that employee share-option schemes in other semi-states are likely to follow in the wake of the Telecom Eireann deal. Meanwhile, Ryanair has become the first Irish public company to introduce a company-wide share option scheme.

Ryanair's decision is likely to be the first of many, as Irish companies copy a practice popular for many years in the US, where employees are given an incentive by being offered shares and share options in their company.

In the future, employees are as likely to compare their stock-option schemes, as much as their salaries.

Employee share-option and profit-sharing schemes are a "tool" to make employees participate more fully in their company, according to Mr Greg Sparks, partner at Farrell Grant Sparks. His firm recently published a guide to giving employees equity and he says the process has advantages for both sides.

Employers, in return for providing employees with share options, get a more loyal and motivated workforce and can link giving shares to achieving profit and productivity targets. For example, the Ryanair scheme, involving all of its employees, hinges around the company growing its net profit by 20 per cent a year.

A spokesman for Ryanair says the scheme means employees have an extra incentive to achieve the results.

The biggest advantage for employees is they can substantially increase their income and in some cases increase their say in the running of the company.

In the case of the ESOP at Telecom Eireann, the employees 14.9 per cent equity is held in an employee share-option trust (ESOT) which means a representative of these shareholders is entitled to a seat on the board. Mr Sparks says the trust option means employee shareholders have a lot more "clout".

He says the downside is that every time employees decide to sell their shares, their power to influence the company's direction decreases.

Telecom employees received some shares in return for negotiating new practices and will effectively pay for the remainder through foregoing bonuses, making their own pension contributions and cash payments. The offer of shares is very attractive to employees, like those in Telecom Eireann, who may make as much as £50,000 each when the company floats on the stock market.

With new companies listing all the time, some are likely to reserve part of their equity for their staff as part of a share scheme. While there are likely to be few paper millionaires for some time, young companies listing on the exchange who give a portion of equity to their staff are likely to be giving them substantial extra income.

All this means that companies who have ignored the phenomenon may start to lose some of their staff. A recent survey found that outside offers of stock options was one of the main reasons that staff left one company to join another in the computer and software sector. Salaries in the technology industry have become so competitive that the decision to move from one company to another rests on additional benefits, among them shares.

The survey, by the Cullinane Group, found that just under half of the 32 indigenous and overseas computer companies surveyed offered their employees share options. The survey cited the flotations of CBT and Iona Technologies as raising the issue across the whole sector.

Because of the competition between companies, they are all slow to disclose the exact nature of their scheme. When comparing the ESOP arrangements planned for many State companies, with those of plcs and other companies, the best deal would seem to be with the State sector. This is because if Telecom becomes the accepted model (not entirely certain at this stage) it will mean that future ESOPs will involve all employees getting an equal amount of share options. Meanwhile, the schemes at Intel, Microsoft and Ryanair operate on the basis of each grade of employee getting different numbers of share options.

The rewarding of employees with share options is nothing new for senior executives in most large public companies. Ms Anne Fitzgerald of the Irish Association of Investment Managers (IAIM) says the tax implications of giving directors share options makes it less popular. Despite this, most large public companies have some kind of executive share-option scheme.

IAIM issues voluntary guidelines to listed companies on the practice of executive share-option schemes. According to IAIM the "fundamental responsibility for initiating, operating and controlling share-option schemes lies with companies themselves", although the organisation says there is a high level of compliance with the guidelines.

From the point of view of institutional investors, making equity available to company employees or directors dilutes the interests of shareholders. So IAIM believes that such schemes must be tied to increased performance and enhanced returns to institutional clients.

IAIM says that over three years no more than 3 per cent of the equity of a plc should be appropriated for share options and this is generally observed by most companies.

IAIM's guidelines include detailed performance criterion on companies which are linked to the award of share options. The criterion used is earnings per share, and if this exceeds certain levels then the exercise of options is allowed.

In terms of how many options directors are allowed under the guidelines, the rule is clear. The market value of the total options should not exceed four times the directors annual emoluments.

With employees being increasingly offered shares as part of their work, many are having to grapple with the tax implications for the first time.

The main point to bear in mind is that an employee who receives shares under a Revenue-approved employee scheme is not liable for income tax, once they are held for three years. When the shares are disposed of, the employee may still have to pay capital gains tax at 20 per cent, depending on the price of the shares.

These provisions only apply to employee share plans approved by the Revenue Commissioners. Schemes are only approved by the Revenue if the shares are held in trust, which is the case with Telecom Eireann.

People participating in non-approved schemes with share options are liable for income tax at either the lower or higher rate depending on their overall income. The tax is charged on the difference between the market value of the share option when it is received and its value if exercised. There is also a separate capital gains charge if the shares are cashed. The Revenue does allow employees or directors the chance, in certain circumstances, to defer or roll-over the payment of CGT arising on the disposal of their shares. They can defer the CGT if the proceeds from the disposal of the shares are re-invested in an unquoted trading company within three years of the date of disposal. Payment of CGT on the gain is deferred until the new shares are, in turn, sold.

This gain can be deferred again where the proceeds from the new investment are re-invested in a further company which qualifies.