Employee stock ownership plan – ready for wider adoption?

Imagine if majority of the working population are part owners of the company where they work. Imagine the enthusiasm and excitement this possibility can infuse into the workplace! Aside from an increase in productivity as a result of employees’ awareness of their share in the company’s profit, employee retention may also remain high and result in a stable succession.

Employee ownership can be accomplished in a variety of ways: employees can buy shares of stock directly from the company, receive stock options at a specified exercise price, obtain shares through a profit-sharing plan, or this could be awarded as a bonus. Of these avenues, the employee stock option plan (ESOP) is, perhaps, the least popular route to increasing employee ownership. ESOP is a kind of employee benefit plan, similar in some ways to a profit-sharing plan. In an ESOP, a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares.

Given the possible benefits to the company and its employees, why is issuing ESOP not common in the Philippines? As an auditor for almost 20 years, I only came across very few clients that offer ESOP or similar plans to their employees. In contrast, there were about 7,000 companies in the United States with ESOPs covering 13.5 million employees in 2014, according to the National Center for Employee Ownership website (www.nceo.org).

Are there regulations concerning ESOP? There are regulatory, taxation and accounting policies for ESOP already in place; the Bureau of Internal Revenue has issued Revenue Memorandum Circular (RMC) 79-2014, while the Philippine Financial Reporting Standards has issued PFRS 2, Share-based Payment. The Securities and Exchange Commission (SEC) has issued the implementing rules of the Securities Regulation Code, with some provisions covering ESOP.

How about the valuation of the subject shares? Unlike the shares of publicly traded corporations whose valuation are publicly known, there is a probable difficulty valuing the shares of privately held corporations. However, with a lot of valuation models and techniques and a number of entities doing valuation, there is a way to determine the value of the shares even for privately held corporations.

So, if regulation and valuation are not the issue, what then? In my opinion, the possible reason why ESOP and similar plans do not gain traction is its unattractiveness both from the business owners’ and the employees’ points of view.

For business owners, having employees as stockholders would mean a lot more individuals will look into the business affairs of the corporation (e.g. demand to examine the company’s financial statements, criticize the entity’s business strategy, etc.). Also, with numerous stockholders to consult with and get approval from, the execution of the entity’s business plan could be delayed. Moreover, if the business owners want to dispose of the business, possible buyers may back out due to numerous minority owners.

On the part of the employees, some may find stock option plans unfavorable because many of them prefer to receive their bonuses and incentives in cash. Also, employees particularly of privately held firms may find difficulty when they want to leave the company. In addition to exit concerns, very few corporations in our country regularly declare dividends, which creates an issue over expected returns.

To spur growth of ESOP and similar plans in our country, some incentives are, indeed, needed. For business owners, ESOP is a path for transparency and better corporate governance. Involved employees will be more engaged and motivated in doing their work to help the company grow, since the value of the shares they are due to receive depends on the value of the company. The company will also be able to free up funds for investment purposes, which could spur growth for the company. Also, employees may ask the company to go public, which could drive up the number of publicly listed entities and could eventually stimulate further development of the capital market in the country. The SEC may also consider granting full exemption for shares of privately held corporations from registration with ESOP or similar plans, regardless of the number of employees involved.

One other possible incentive is to grant tax exemption for the benefits received by employees. ESOP can be likened to a retirement benefit plan if it is granted or converted upon retirement of the employee. The value of the shares given can be more equitable than the traditional retirement benefit plan (which is usually based on one-month salary for every year of service) as the converted value of the shares received will be based on the value of the entity in which the employee has direct participation and to which he or she has direct contribution. Also, to address the exit option issue, the company may be required to put up a sinking or trust fund to guarantee the buy-back or cash conversion upon an employee’s resignation.

ESOP can bring a lot of benefits and value to both the company and its employees. I believe it is the right time for Philippine companies to seriously look into this important matter.

Boyet Murcia is Partner, Audit & Assurance of P&A Grant Thornton. P&A Grant Thornton is one of the leading Audit, Tax, Advisory, and Outsourcing firm in the Philippines, with 20 Partners and over 700 staff members.

As published in The Manila Times dated 25 May 2016