Although receiving extensive press coverage recently, particularly with stories of “fat cat” directors receiving millions of pounds worth of share options, the concept of share ownership by a company’s workforce isn’t a new one.
For years, many enlightened companies have offered staff incentives of this type. For some, the motivation has been to align the interests of employees with those of shareholders, the theory here being to incentivise the workforce to work towards an increase in share value.
For others, the main driver has been one of tax-efficiency. It is only recently that successive governments have taken the necessary steps to ensure that whether or not an employee is remunerated in cash or in kind, broadly the same amount of tax and National Insurance is levied on them. Until recently, non-cash benefits thrived.
More than any other factor, it was this difference in tax treatment between cash remuneration and benefits-in-kind, which led to the idea of company cars being provided for employees other than salesmen. From cars, the idea developed into fine wines, works of art, gold bars and various other somewhat exotic salary-substitutes. Shares and share options were, for many, simply another way of remunerating staff in a tax-efficient manner. This tax-efficiency was in many ways state aided. It has been possible for some years to set up schemes with government-sponsored tax breaks, be they executive share options schemes, profit-sharing schemes, or savings-related share option schemes.
However, it is only recently that there has been a really concerted effort to widen the appeal of the available plans to encourage as many companies as possible to sign up their workforce. In particular, the All Employee Share Ownership Plans and Enterprise Management Incentives introduced by the present government to foster the principles of free enterprise, have been taken up enthusiastically in many quarters.
In talking to the Inland Revenue about “borderline” cases, it is quite clear that it is under instructions to include as many companies in the scheme as possible to ensure success. In other words, the brief is to interpret the rules to allow people to qualify wherever possible, rather than to exclude them.
The question that remains, therefore, is whether these schemes are a “good thing”. Do companies that reward staff with shares and share options outperform those who remunerate their workforce in more conventional ways via salary, bonuses, company cars, private medical insurance and so on?
To provide an answer, you must consider the question from the perspective both of employer and employee. It is also of crucial importance to distinguish between public companies, whose shares are quoted on the London Stock Exchange, for example, and private companies, where the majority of shares (and therefore power) is often held by a small number of individuals.
For the employer, giving share options is often preferable to cash. Shareholders might prefer to suffer some dilution of their holdings rather than suffer “real” cost on the profit and loss account by providing salaries or other benefits.
An award of shares or share options will also give the employees a greater feeling of ownership and “common goal”, which are often said to lead to even greater productivity. Added to this is the “lock-in” value of a shareholding, particularly where the scheme only rewards staff who remain in the company’s employment for a given period of time. This is particularly important in those “people businesses” where the workforce represents the company’s most valuable asset.
What, then, could be the disadvantage in offering shares or share options? Does the above not prove the case beyond doubt? Is this not especially true if the shares or options can be awarded in a tax-efficient manner?
Well, in the first place, some employees may not be willing to accept “jam tomorrow”. Their own personal circumstances may mean that they are not in a position to accept anything other than the greatest immediate cash reward that they can obtain. High mortgage commitments, school fees or similar, may put too great a strain on their personal finances.
Second, they may not wish to be locked-in. Just as it pays the company to try and secure the loyalty of employees by rewarding them in this fashion, the employees themselves may prefer to have the flexibility to earn well in the short-term, and then perhaps move to a more lucrative position with a competitor at a later date.
Perhaps most important of all, is the question of realising value for the shares. Shares, particularly those in private companies, are not assets that are easily convertible into cash. And many companies have provisions in their Articles of Association which mean that any employee or shareholder who does wish to realise his or her investment may receive far less than what is considered to be a full value. Pre-emption rights and other restrictions associated with the shares may mean that the shares are worth only a fraction of their true value on sale.
In the case of fully quoted shares, this is much less of a problem since the shares can normally be bought and sold through a stockbroker at more or less full value at any time. But private companies work in different ways.
And this is the bottom line. I have seen many directors of private companies reward their staff with shares, knowing that this is the “cheap” option and with frankly too little regards for the outcome as far as the workforce is concerned. Yet, when the penny finally drops and the employees realise how illiquid their investment in the firm really is, what effect does this have? Far from incentivising employees and giving them a common goal, it does quite the opposite. The staff become disillusioned; productivity falls; divisions are created.
So while wider share ownership is undoubtedly a good thing in theory, the practical implementation of a scheme is often much more difficult. In my view, it is absolutely crucial that the company has a very clear idea from the outset as to what tangible rewards are likely to result and over what time period. Failure to give this matter full consideration will often lead to such a scheme doing more harm than good.
Andrew White is senior partner of Gordon Leighton Chartered Accountants
Further information: www.inlandrevenue.gov.UK/shareschemes/
Telephone 020 7438 6420 or 020 7438 6425
To mark its 40th anniversary in April, architect and design group Building Design Partnership took advantage of the All Employee Share Ownership Plan, recently launched by Chancellor of the Exchequer Gordon Brown. BDP restructured its capital into shares to become a group of companies owned by BDP Holdings. This entitled it to open up ownership beyond its directors.
AESOP allows the staff to buy shares in BDP out of their salaries, with tax relief. Once a quarter, shares are bought and sold via an internal market mechanism. As the group is still privately owned, the shares will be valued annually with the Inland Revenue.