A share incentive scheme is certainly a cheaper alternative to giving cash bonuses or pay rises, writes Caroline Madden

FOR CASH-STRAPPED companies looking for a cost-effective method of rewarding and motivating staff, share incentive schemes may be the answer to their problems. Offering employees a stake in the business is certainly a cheaper alternative to giving cash bonuses or pay raises. However, employers who decide to go down this route may have to run the gauntlet of disgruntled shareholders.

Employee share schemes are particularly common in multinationals such as Intel, which awards stock benefits to more than 90 per cent of its workforce. Mike Namie, global equity manager for the chip manufacturer, spoke this week at an Irish ProShares Association conference in Dublin on the issue of employee financial involvement in a challenging economic environment.

He explained that Intel awards a mixture of stock options and restricted stock units (which provide an employee with an entitlement to a future award of shares), and will continue to do so. Not only does it support the company's philosophy of egalitarianism, but according to Namie, this approach is also a "very cost-efficient way for Intel to deliver value to employees".

"[It] is a non-cash expense for Intel so, especially in this type of an environment, it allows us to still deliver good value to employees through our stock benefits without using cash," he explains. Every dollar that Intel pays to an employee through their base salary or bonus actually costs the company roughly $1.30 when knock-on costs are factored in, so awarding a dollar's worth of shares is more cost-effective.

In Ireland, costs incurred by companies in establishing and running a share scheme are deductible for corporation tax purposes. And the employer will make a major saving as they won't have to pay PRSI contributions at 10.75 per cent on share-based benefits awarded to staff.

John Bradley, partner of KPMG's employment tax service practice, points out that if, for example, a company has a bonus pool of €10 million, and the employees agree to receive their bonuses through a suitably structured share scheme (for example, an Approved Profit-Sharing Scheme, or APSS), instead of in cash, the employer will save more than €1 million in PRSI.

With an APSS, the employer can award shares worth up to €12,700 a year to an employee. A major benefit from the employee's perspective is that, as long as they hold onto these shares for three years, they won't have to pay any income tax on the benefit. However, capital gains tax at 22 per cent will apply if they sell the shares at a gain.

Sheena Doggett, head of AL Goodbody's benefits group, says profit-sharing schemes are "a way that companies which don't want to pay cash bonuses can still continue to make bonus awards".

Revenue-approved Save as You Earn (SAYE) share option scheme are another popular option with Irish companies. Under an SAYE scheme, an employee agrees to save a fixed sum for a set period - for example three, five or seven years. At the end of the savings period, they can opt to buy shares in the company at a discount.

As with APSS schemes, they generally won't have to pay income tax, but capital gains tax may apply. The maximum monthly savings limit was increased earlier this year from €320 to €500, making the SAYE scheme even more attractive.

Although share schemes present a cost-effective way of rewarding and motivating staff, implementing them in the current climate may be challenging.

"I would say a lot of companies would find it difficult to go with a new tranche of share schemes, particularly if they're public companies, because they would have to get shareholder approval," Bradley says.

If a shareholder has just watched their investment plummet in value, they're unlikely to vote in favour of more shares being awarded to executives in the company, he explains. Shareholders are more likely to want the executives to share their pain.

"In private companies there may be more of a willingness to give shares instead of cash," he says.

"If they're strapped for cash . . . shares might be an alternative."

However, private companies face their own difficulties in implementing a share scheme. As they aren't listed on a stock exchange, it can be difficult to establish the market value of shares in a private company, and it may also be harder to sell the shares.

It could be argued that this is a good time to receive stock benefits; share prices are so low now that employees would stand to make serious gains if markets rebound.

However, Bradley points out that there are two sides to this equation: "If I'm an employee, do I want to take shares that may continue to slide instead of getting cash? It's an investment decision for me as an employee as much as anything else."

"Cash is always king," Doggett observes. "But you [the employee] pay income tax on cash and the employer will have to pay PRSI at 10.75 per cent, so cash is more expensive."

Share options are commonly used to reward and retain senior executives, for example, at the upper echelons of Irish banks. A share option is a right granted to an employee or director to buy shares in the company at a future date, at a specified price called the exercise or strike price. If the company's share price rises, the employee has the opportunity to make a profit by exercising their option and buying the share for less than the market price.

That's all well and good during a bull market, but with share prices continuing to plumb new depths - Bank of Ireland and Anglo Irish Bank's share price both fell below the €1 mark this week - many employees now find that their share options are "under water" or worthless because the market price has fallen below the exercise price of their options.

What can companies do to alleviate this hit? One option is to lower the strike price of the options already issued, but companies normally need to get approval from their shareholders to take this step. As shareholders are themselves nursing losses, they are unlikely to be sympathetic towards bailing out employees. "Listed companies will be reluctant to go back to the market and seek shareholder approval," says Doggett.

Another alternative is to extend the lifespan of the share options. Generally options must be exercised within a specified timeframe, for example, four years, or else they expire.

By extending this time limit, the logic is that there's a greater chance of the market price recovering enough for the options to come back "into the money".

Even if companies adopt this strategy, for now underwater options have lost the "golden handcuff" effect that they had when share prices were soaring. But with unemployment pushing 7 per cent, employers are unlikely to see a mass exodus of executives any time soon.