News: Mahindra to gift Rs. 500 cr. in company stock to over 14,000 workers as Diwali bonus through Restricted Stock Units (RSUs), a form of employee stock option plan (ESOP).
About Employee Stock Option Plan (ESOP)
- An Employee Stock Option Plan (ESOP) is a benefit scheme where companies offer employees the right to buy shares at a predetermined price after a specific period.
- It is a way to reward employees, align their interests with the company’s success, and improve motivation and retention.
- Reasons to provide ESOP: Companies provide ESOPs for several reasons –
- Employee Retention: Employees stay longer to receive their stock options.
- Performance Incentive: Employees are motivated to improve company performance, leading to higher stock value
- Ownership Culture: Employees feel like stakeholders, fostering loyalty and commitment.
- Alternative to Cash Compensation: Start-ups and companies with limited cash can use ESOPs as a reward mechanism
- Working procedure
- Grant of Options: The company gives employees the option (not obligation) to buy shares at a fixed price
- Vesting Period: Employees must stay with the company for a specified time before they can exercise their options.
- Exercise Period: After the vesting period, employees can purchase shares at the predetermined price.
- Selling Shares: Once exercised, employees can sell shares in the open market, benefiting from price appreciation.
- Key Terms in ESOPs
- Stock Options: The right to buy shares in the future at a fixed price.
- Vesting Period: The time an employee must wait before exercising options (minimum 1 year as per SEBI regulations).
- Exercise Price (Strike Price): The price at which employees can buy shares.
- Exercise Period: The window during which employees can purchase shares after vesting.
- Expiration Date: The deadline to exercise stock options before they become invalid.
- ESOPs in India are regulated by
- SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 for listed companies.
- Companies Act, 2013 for unlisted companies.
- Tax rules under the Income Tax Act, 1961, where employees are taxed at the time of exercising options and again when selling shares.
- Process for Employees
- Option Grant: The company offers stock options to eligible employees.
- Vesting Period Completion: Employees meet the service duration requirement.
- Exercise of Options: Employees purchase shares at the pre-decided price.
- Selling Shares: Shares can be sold in the open market, subject to tax and lock-in rules.
- Benefits for Employees
- Opportunity to own company shares at a lower price.
- Potential for significant wealth creation if stock price increases.
- Aligns employee growth with company success.
- Risks for Employees
- If stock price falls, options may lose value.
- Employees need to pay upfront to buy shares.
- Taxes apply at the time of exercise and sale.
