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Employee Stock Option Plans: A Study Labour Law I

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1.0. Introduction Traditionally, every Joint Stock Company had three distinct groups of persons involved in the working of the company, namely, the shareholders, the top management and the shareholders of the company. The employees received a fixed remuneration in the form of salary or wages, while the shareholders received dividends based on the performance of the company. The employees were seldom considered an integral part of the company and their work was aimed to benefit the shareholders and there was no relation between the amount of profits and the remuneration received by the employee. ‘The employees were not motivated to work harder for the company as the company’s benefit meant only the benefit of the shareholders.’1 Furthermore, the bonus received by the employees varied very little and had no link to his effort.

However, the Nineties have witnessed a gradual shift towards employeeoriented management. Employers have now realized the value of human assets and lay emphasis on several factors such as working atmosphere, perks, performance related incentives, etc. One of the tools evolved in this context is that of Employees’ Stock Option Plan (Hereinafter referred to as ESOP).

Black’s law dictionary describes an employee stock ownership plan as a “profit sharing plan designed primarily to give an employee retirement benefits and a stake in the company, but also used to allow employees to purchase their employer company if it is closing.”2 Additionally, a stock option has also been described as an option to buy or sell a specific quantity of stock at a designated price for a specified period regardless of shifts in market value during the period. 3 Drawing a line from this definition, an employee stock option would be an option that allows a corporate employee to buy shares of corporate stock at a fixed price or within a fixed period.

ESOPs have become increasingly popular in the modern era. In fact, a study carried out in the US estimates that employees own, or have options to own stock worth about $800 billion, or about 8% of all the stock in the United States. 4 A number 1

A d a m R e yn o l d s , “ D o E S O P s s t r e n g t h e n em p l o ye e s t a k e h o l d e r i n t e r e s t s ? ” , 1 3 Bond Law Review 27.

2 B l a c k ’ s L a w D i c t i o n a r y, 7 t h E d . , 1 9 9 9 a t p . 5 4 3 .

3 M . K r i s h n a n , “ E S O P I s N o t A P e rk - R e t r o a c t i v e N a t u r e o f t h e F i n a n c e A c t , 2 0 0 0 ” , (2001) 165 CTR (Articles) at p.250.

4 h t t p : / / www. n c e o . o r g / l i b r a r y/ o v e r v i e w. h t m l ( v i s i t e d o n 2 n d S e p t em b e r , 2 0 0 2 ) .

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of reasons have been attributed for the same. Authors have argued that ESOPs not only provide employers attractive tax benefits, but also have potential productivity gains.5 Additionally, the employees to employees have now begun to expect ‘equity’. 6 This is especially true in cases of firms involved in the technology sector, where it is increasingly the norm to offer all employees ‘stock options’.

However, the use of ESOPs has had its ramifications on the employeremployee relationship and altered the labour-management equation. It is the endeavor of this research paper to analyze the same through the means of case staudies.

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S t u d i e s h a v e s h o wn t h a t wh e n b r o a d em p l o ye e o wn e r s h i p i s c om b i n e d wi t h a h i g h l y p a r t i c i p a t i v e m an a g e m e n t s t yl e , c o m p a n i e s p e rf o rm m uc h b e t t e r t h a n t h e y o t h e r wi s e wo u l d b e e x p e c t e d t o d o .

6 Infra Part IV of this Paper.

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2.0. Research Methodology The theme of the present research paper is to study the increasingly popular phenomenon of ESOPs (Employee Stock Options). Though of recent origin, there is an abundance of secondary sources on the subject, majority of which are available on the World Wide Web. However, the researchers have chosen not to excessively rely upon secondary sources of data and have instead sought to conduct their own independent case studies and arrive that their own conclusions.

Thus, the present paper is more a compilation of field-studies conducted by the researchers in Infosys Ltd., a highly reputed software company based in Bangalore and Transport Co-operative Services (TCS), Koppa, a relatively lesser known bus service being run on a co-operative basis.

Since the researcher’s themselves have conducted the field studies the research material is primary in nature and basically consist of interviews, field research, questionnaires, etc. However, secondary sources of data such as books, articles, websites, etc. have been used to understand the theoretical and legal underpinnings to the concept of ESOPs. The researchers in this project have used an analytical and descriptive style of writing. Facts, questions and observations have been re-produced in descriptive style and an analytical approach has been adopted to compare the two models of stock options and employee participation adopted by the two diverse corporations.

Footnotes wherever necessary have been cited in a uniform manner.

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Part I 3.0. ESOPs: Theoretical Underpinnings -- Michael Sailo, Blii 935.

3.1. History of ESOPs

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Louis Kelso, a lawyer and investment banker developed the whole concept of employee stock options and ESOPs as a whole in the 1950s. He believed that the capitalist system would be stronger if all workers would be stronger if all workers, not just a few stockholders, could share in owning capital-producing assets. But at the time, few companies and firms took up his idea. However, his concept took a new turn of importance when he convinced the Chairman of the tax writing Senate Finance Committee, Senator Russell Long, that tax benefits for ESOPs should be permitted and encouraged under employee benefit law. Soon, the US Federal legislation promoting ESOPs appeared. This was the Employee Retirement Income Security Act of 1974 (ERISA), which governs employee benefit plans and established a statutory framework for ESOPs. Thereafter, the number of stock options expanded dramatically now that sharing ownership was in the economic self-interest of company owners. Henceforth, it spread to other countries of the world and was taken up firstly by American multinationals and then the practice became worldwide subsequently. Since then, the laws governing ESOPs have been modified and changed and there have been minor and institutional changes but the principle as a whole has remained the same.

3.2. Rights Under Employee Stock Options The rights of the ‘employee owners’ as regards their stock options vary according to the type of stock option plans they have been granted. Though, no case regarding the right of employees as regards has come before the Indian Courts, in the US the rights granted to the employees under ESOPs have been sough to be strictly enforced. In the case of Lamb v. Emhart Corporation8 this matter was debated at some length. In the instant case the matter was with regard to damages for breach of stock option agreement. In this case, the defendant employer challenged the lower court’s decision ordering the defendant to pay the plaintiff employees for stock options available under the defendant’s amended retirement plan. The defendant had 7

For a detailed dissertation on the subject see Gina Marie Agresta-Richardson, " E m p l o ye e S t o ck O wn e r s h i p P l a n s : U n c e r t a i n t i e s P l a g u i n g t h e D u t i e s o f t h e E S O P F i d u c i a r y wi t h R e s p e c t t o V o t i n g a n d D e f e n s i v e E S O P s ” , 1 4 A k r o n T a x J . 9 1 .

8 C o m p l e t e t e x t of t h e j u d gm e n t i s a v a i l a b l e o n h t t p s : / / www. l e x i s . c o m / r e s e a r c h / r e t r i e v e ? _ m = 5 d 1 c 7f d 8 d a 3 0 4 2 f 9f 9 1 6 7f 2 e 9 2 1 4 4 4 d 3 & d o c n u m = 6 & _ f m t s t r= F U L L & _ s t a r t d o c = 1 & wc h p = d G L b V z zl S lW k & _m d 5= c 4 3 1 b b e 4 b b 2 c 5 c a 5 1 5 1 f e 9fc9dafe318.

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discharged the plaintiffs in a corporate reorganization. The plaintiff’s termination agreements incorporated by reference the defendant’s stock option plan, which permitted exercise of option within three months of termination. The defendant later amended its stock option plan to accelerate option rights in the event of a company takeover but failed to notify plaintiffs of the amendment. The defendant merged with another company within three months of the plaintiff’s terminations and liquidated the plaintiff’s stock options, mailing plaintiffs checks for their unexercised option shares at the reduced value assigned to unexercised shares. On appeal, the court held that the amended stock option plan was incorporated by reference into plaintiff’s termination agreements, even thought the plan had not been amended as of plaintiff’s separation date. Plaintiff’s cashing of defendant’s liquidation cheques did not constitute an accord and satisfaction or bar plaintiff’s breach of contract suit. The court affirmed the district court’s decision requiring defendant employer to pay the plaintiff employees for stock options at their accelerated value as provided by defendant’s retirement plan as amended after plaintiff’s date of separation because the amended plan was incorporated by reference into the plaintiff’s termination agreements.

It must also be noted that in the US there have been numerous lawsuits against ESOP sponsors, advisors and trustees. Most of these are concerned with improper valuations, misuse of assets, broken pledges or excessive management enrichment to the detriment of plan participants.9 Thus, the US Courts have been of the view that ESOP participants can sue on their own behalf or as part of a class for any violation of the rights, which have been granted to them.

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A l a n H yd e , “ T h e K e n n e t h M . P i p e r L e c t u r e : I n D ef e n s e O f E m p l o ye e O wn e r s h i p ” , 67 Chi.Kent. L. Rev. 159.

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Part II 4.0. The Legal Framework Surrounding ESOPs in India -- Anunay Shahi, bli912 & Rahul Sharma, bli950.

4.1. Legal Validity and Working of ESOPs When ESOPs were first introduced in India, the existing legal framework did not tackle the issue in any respect. A great deal of confusion prevailed with regard to legal hurdles that had to be crossed before these schemes could be successfully implemented. SEBI regulated the same in a very limited way as a part of the SEBI (Disclosure and Investor Protection) Guidelines. 10 However, these Guidelines did not deal with the matter thoroughly and did not help to clear the prevailing confusion.

Thus, in November 1997, SEBI constituted a Committee, headed by Prof J. R. Varma, to review the Regulations relating to Employee Stock Option Plans. 11 The Committee consisted of eminent personalities from different walks of life. 12 The Committee placed on record the importance of ESOPs in “rewarding and motivating employees, in attracting and retaining the best talent, and in ensuring employee commitment and performance.” The twin principles, which the Committee suggested in framing guidelines in relation to ESOPs, were complete disclosure and shareholder approval. It was also accepted that once these principles are recognized, the regulators should interfere very little in the issue of Employee Stock Options. The aim of the committee was to facilitate as many forms of ESOPs as possible and clear the various legal obstacles that existed. Several suggestions were made relating to various aspects of an ESOP namely pricing, quantum lock-in and vesting, disclosure, taxation etc. Most of these recommendations were incorporated by the SEBI in SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999.13

4.1.1. The ESOP Guidelines These guidelines were made effective from 19 th June, 1999 and attempted to make clear various doubts with regard to the legal validity of ESOPs and their working. These Guidelines deal only with Employee Stock Option Scheme 14 and 10

M . K r i s h n a n , “ E S O P I s N o t A P e rk - R e t r o a c t i v e N a t u r e o f t h e F i n a n c e A c t , 2 0 0 0 ” , (2001) 165 CTR (Articles) at p.250.

11 R e p o r t of t h e C om m i t t e e o n E S O P s , www. s e b i . g o v . i n / p r e s s / 9 9 1 3 5 r e p o r t . h t m l (Visited on 9th September, 2002).

12 T h e C o m m i t t e e m e m b e r s i n c l u d e d N R N a r a ya n a M u r t h y, N i s h i t h D e s a i , S a u r a b h Srivastava & Vijay Ranjan.

13 H e r e i n a f t e r r ef e r r e d t o a s E S O P G u i d e l i n e s .

14 H e r e i n a f t e r r ef e r r e d t o a s E S O S .

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Employee Share Purchase Scheme15 as they are more in vogue in the present context and do not cover the other forms of Employee Incentive Schemes. The Guidelines prescribed that only Companies listed on the Stock Exchanges have to comply with these guidelines.16

The ESOP guidelines, which inter alia deal with following areas, provide for the following: a. Eligibility: At the threshold level, it is necessary that only those employees eligible under the ESOP Guidelines be given the option of subscribing to the shares of the Company. In this light, Para 4 of the guidelines has stated an employee as defined in Para 2.1 of the Guidelines will be eligible to participate in an ESOS.17 A promoter or a director who holds more than 10% of the outstanding equity shares of the Company is not eligible to participate in the Scheme. This is to prevent insiders of the Company from acquiring a controlling interest in the Company and also from using their pre-eminent position in the Company to acquire shares on favourable terms. The same is also applicable to a scheme of ESPS. This is in pursuance of the recommendations of the J.S. Verma Committee Report. b. Compensation Committee: This is a mandatory administrative requirement for every ESOS. The ESOP guidelines provide that there shall be a Compensation Committee consisting of a majority of independent directors and that it shall formulate the detailed terms and conditions of the ESOS with respect to matters such as quantum of option, conditions for lapsing of an option, exercise period etc. Independent directors need to be on the Committee to prevent interested directors from framing an ESOP scheme, which is favourable to themselves. The Committee has also to ensure compliance with the Insider Trading Regulations and the Regulations relating to the Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market.

c. Shareholder Approval: In pursuance of the recommendations of the J. S. Varma Committee, Para 6 of the ESOP Guidelines mandate that every ESOS 15

H e r e i n a f t e r r ef e r r e d t o a s E S P S .

P a r a 3 . 1 of t h e E S O P G u i d e l i n e s .

17 A s p e r P a r a 2 . 1 ( 1 ) , A n “ E m p l o ye e m e a n s ( a ) A p e rm a n e n t em p l o ye e o f t h e C o m p a n y wo r k i n g i n I n d i a o r o u t of I n d i a ; o r ( b ) a d i r e c t o r o f t h e C om p a n y, wh e t h e r a wh o l e t im e d i r e c t o r o r n o t ; o r ( c ) a n em p l o ye e a s d e f i n e d i n s u b - c l a u s e s ( a ) o r ( b ) o f a s u b s i d i a r y, i n I n d i a o r o u t o f I n d i a o r of a h o l d i n g c o m p a n y of t h e C o m p a n y. �

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Employee Stock Option Plans: A Study Labour Law I

should be approved at a meeting of the Shareholders of the Company by passing a Special Resolution. In pursuance of S. 173(2) of the Companies Act, 1956, the explanatory statement to the notice of the special resolution should contain inter alia information relating to the total number of options, the class of employees entitled to participate in the ESOS, exercise price or pricing formula, exercise period, maximum number of options per employee, etc. A special resolution on this matter is necessary, as the shareholders are the ones most adversely affected by the grant of ESOS as it dilutes their stake in the Company.18

d. Pricing: The Guidelines follow the J. S. Varma Committee report and allow the Companies the freedom to price the options as they wish. As the employees were initially likely to be sceptical with regard to purchase of shares, the Committee felt that the Companies should be allowed to price their options so as to attract their employees. The ESOP also mandate that the ‘accounting value of all options be treated as another form of employee compensation in the financial statements of Companies.’19 These Guidelines do not allow for a phased transition in the manner, which was recommended by the Committee.

The view taken by SEBI seems to be correct as the mode of accounting treatment prescribed by the Committee may not be accurately reflect the effect of an ESOP on the Company's Financial Position.

e. Non-Transferability of Option and Lock In Period: As an option is a personal right, it can be exercised only by the employee and shall not be transferable to any other person. One of the objectives of an ESOP is to secure the loyalty of the employee to the Company and this would be defeated if the employee were allowed to transfer options immediately after being granted the same.20 In the case of an ESOS, the Guidelines prescribe that the Company has the freedom to specify the lock in period for the shares issued pursuant to the exercise of the option.

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S e c t i o n 1 8 9 ( 2 ) of t h e C o m p a n i e s A c t m a n d a t e s t h a t e v e r y s p e c i a l r e s o l u t i o n n e e d s t o b e p a s s e d wi t h a t h r e e f o u r t h m a j o r i t y a n d t h e n o t i c e of t h e s p e c i a l r e s o l u t i o n m u s t s p e c if y t h a t i t i s a s p e c i a l r e s o l u t i o n .

19 This is applicable both in case of ESOS and ESPS. 20 E m p l o ye r s s u c h a s I nf o s ys u s e E S O P s a s a m e t h o d of e n s u r i n g t h a t em p l o ye e s r e m a i n i n t h e C om p a n y f o r a l o n g t im e .

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f. Directors' Disclosure: The Guidelines implement the policy suggested by the Committee Report, namely that of Maximum Disclosure and prescribed that the Directors' Report disclose various details of the ESOS including the pricing formula, options granted, options vested, options exercised, options lapsed, variation of terms in options and other similar details.

g. ESOS and ESPS: The ESOP Guidelines are more liberal with regard to ESPS as compared to ESOS. The issue of ESOS does not require a Compensation Committee to be formed prior to the offer of ESPS. Also, shares issued to the employee under this scheme are freely transferable. This may defeat the objective of ensuring employee loyalty. With respect to lock in period in relation to shares issued by an ESPS, a minimum period of one year has been mandated as distinguished from shares issued by an ESOS where the Company concerned is free to specify the lock in period.21 This is probably because in the case of an ESOS, there is a requirement of a minimum period of one year between the grant and vesting of option.22 On the other hand, ESPS being a share purchase scheme, the vesting of shares is immediate.

As far as the ESOP guidelines are concerned, they are a definite step in the right direction. Extensive legal regulation has been eschewed in favour of allowing the Companies to frame their own schemes provided that they meet the broad requirements of the Guidelines. The most important feature seems to be that of shareholder approval by a special resolution. This feature should never be eroded as it would lead to dilution of the existing shareholders' value in the company.

4.2. Tax Implications of ESOPs There are four distinct stages involved in stock options:

21

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Grant of options;

•

Vesting of options (the point of time when the option becomes exercisable;

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The exercise of the option; and

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The sale (if any) of the shares arising out of the option. 23

S e e P a r a 1 8 . 2 of t h e S E B I E S O P G u i d e l i n e s .

S e e P a r a 9 . 1 of t h e S E B I E S O P G u i d e l i n e s .

23 M . S . P r a s a d , “ G u i d e l i n e s f o r E S O P s u n d e r I n c o m e T a x A c t – A r e v i e w” , [ 2 0 0 1 ] 4 5 CLA (Mag.) at p.76.

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4.2.1. Existing provisions relating to taxation of ESOPs Section 17 of the Income Tax Act defines “Salary”, “Perquisite” and “Profit in lieu of salary”. Section 17(2)(iii) provides that the value of any benefit or amenity granted or provided free of cost or at concessional rate in certain cases by an employer (including a grant from a company to its employee) would be regarded as “perquisite” and as such taxable in the hands of an employee. In order to remove grey areas which existed in the current law relating to the taxability of ESOP transactions and in order to make it clear that provisions relating to “perquisite” would be applicable to the employee to whom specified security is transferred, clause (iiia) was inserted in Section 17 by the Finance Act, 1999.24 Section 17(2)(iii a) applicable from the assessment year 2000-01 (previous year 1999-2000) provides that where any such share or security is directly or indirectly, offered to any assessee by the company or any other person, the difference between the market value of the stock and the cost at which it is offered to the concerned employee shall be taxed as perquisite in the hands of the employee, in the year in which the right of such option is exercised or is exercised and transferred in the name of any other person. It is further provided that the difference between the sale consideration in the event of sale by the employee and market value on the date of exercise of option would be taxed as capital gains in his hands under section 45 in the year of sale.

The Central Board of Direct Taxes (CBDT) has issued a Circular No.710 dated 24th Julv, 1995 in the context of the perquisites in section 17(2)(iii) indicated above.25 The circular makes a distinction between companies in the public sector and companies in the private sector and states that if the Government transfers the shares to an employee of a public sector undertaking, there will be no perquisite. The logic is that there is no employee-employer relationship between the employee and the Government (the company and not the Government is the employer).

Where the shares have been offered only to the employees, the value of the perquisite will be the difference between the market price of the shares on the date of acceptance of the offer by the employee and the price at which the shares have been offered.

24

R L S a n g a n i , “ F i n a n c e B i l l - N e e d f or C l a r i f i c a t i o n i n R e l a t i o n t o P r o v i s i o n s P e r t a i n i n g t o E m p l o ye e s S t o c k O p t i o n P l a n ” , ( 2 0 0 1 ) 1 6 6 C T R ( A r t i c l e s ) a t p . 1 4 3 .

25 G o p a l C h a l am & G a n p a t i M . N a d k a r n i , “ T ax I m p l i c a t i o n s of E S O P s ” , ( 2 0 0 0 ) 1 6 0 CTR (Articles) at p.28.

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The Income Tax provisions relating to ESOPs cause some serious practical hardships, which has been discussed below: a. Tax at the time of exercise of option: The main criticism of taxing at the time of the exercise of the option is that the employee does not receive any cash through mere allotment of shares. To pay the tax, they may have to sell the stocks, which defeats the very objective of the scheme of participation in the management by the employees.

Furthermore, it is unfair to impose taxes on these transactions at two stages, one by way of perquisite at the stage of exercise of option, and the other by way of capital gains at the stage of ultimate transfer by the employee. This amounts to “double taxation”.26 When an employee exercises the option to take the shares and pays for the share, the employee is taxed to the extent of the difference between the 'exercise' price (i.e. the price at which the employee acquires the shares under the scheme) and the market price. This results in the employee paying tax on acquisition, and not on sale. Though there is no profit or realization, tax is payable. 27 When the shares are actually sold, the resultant capital gains are taxed separately. In many countries, the employees who have opted to exercise their option under a scheme are taxed only at the time of exist i.e. sale of shares by them and not at the time of exercise of the option.

There are also practical difficulties in allowing this double taxation. For example, if the market price when the shares are sold is lower than its fair market value, when the option was exercised then, loss under the head ‘capital gains’ would be incurred. But there is no provision for refunding the tax already paid by the employee.

The Government also realized this anomaly after one year and by the Finance Act, 2000 sub-clause (iiia) of section 17(2) and section (2B) of section 49 were deleted with a view to making perquisite value non-taxable and only capital gain

26

Ibid at p.31.

M . K r i s h n a n ’ , “ E S O P I s N o t A P e rk - R e t r o a c t i v e N a t u r e o f t h e F i n a n c e A c t , 2 0 0 0 ” , (2001) 165 CTR (Articles) at p.250.

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taxable.28 However, the amendment was made with effect from 1 st April, 2001 and not from 1st April, 2000 as should have been done.

After this amendment, there was uncertainty on the question as to what should be taken as cost of acquisition of ESOP shares for computing capital gain in the hands of employee when those shares are sold by such employee in whose hands perquisite value had already been taxed. The Finance Bill, 2001 proposes to clarify that in cases where tax has been levied on perquisite employee at the time of exercise of option by the employee, the value adopted under section 17 (2) in relation to such perquisite would be the cost of acquisition of shares for working out the capital gain.29 This provision is sought to be inserted in the proposed sub-section (2AA) of section 49 of the Income Tax Act. 4.3. Accounting for ESOPs ESOPs was activated in India with the insertion of Section 79A in the Companies Act, 1956 by the Companies (Amendment) Act, 1999. The Finance Act, 1999 has introduced provisions relating to the taxability of ESOPs. There are no guidelines at present issued by the Institute of Chartered Accountants of India (ICAI) with respect to accounting of ESOPs in the absence of which companies may account for the cost associated with the ESOP as per methods which may not be in consonance with recognized accounting norms. There is on the other hand, the Statement of Financial Accounting (FAS) 123 on Accounting for Stock Based Compensation issued by the Financial Accounting Standard Board (FASB). 30 Furthermore, Schedule II of the SEBI Guidelines, 1999 deals with the Accounting policies for ESOPs.31 As far as the SEBI guidelines are concerned, it is not known whether they have been prepared in consultation with the ICAI. Another point to be noted here is that Section 79A (d) of the Companies Act has given powers to SEBI to prescribe the guidelines for issuing ESOPs and not for the accounting treatment of the same which is within the rule making powers of ICAI. So, the question that has to be addressed is

28

T N P a n d e y, “T a x a b i l i t y of P e r q u i s i t e R e l a t a b l e T o S t o c k O p t i o n s – N o R e l i ef i n Budget 2000-2001”, 109 Taxman (2000) at p.77.

29 Id. 30 S a c h i n V a s u d e v a , “ A c c o u n t i n g f o r em p l o ye e s t o c k o p t i o n s ” , 2 6 ( 6 ) , S E B I &Corporate Laws (2000) at p.118.

31 M K r i s h n a n , “ A c c o u n t i n g T r e a tm e n t o f Em p l o ye e S t o c k O p t i o n S c h e m e ” , 1 6 7 ( 4 ) , Current Tax Reporter (2001) at p.153.

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that whether SEBI has gone beyond its powers as envisaged under Section 79A (d).

As a result, there could be errors in the mandates issued by SEBI. 4.3.1. SEBI Guidelines: The SEBI guidelines are applicable only to companies whose shares are listed on the stock exchange. As per the guidelines, two methods have been given to arrive at the fair value of the option. Firstly, there is the option discount method and the other is the Black Scholes Model. 32 Option discount means the excess of the market price of the share at the date of the grant of the option under ESOP over the exercise price of the option. But as per the FAS 123, this method excludes the value of the right to purchase the underlying stock at a fixed price for a specified future period-time value.33 Therefore, the option discount method does not reflect the correct cost to be recognized. The Black Scholes method allows the entity either to estimate at the grant date the number of options expected to vest or to recognize compensation cost each period based on the number of options not yet forfeited.

4.3.2. Market price of share: It is the view of the researchers that as a result of the SEBI guidelines, the market price of equity shares would be reflected in the account books. Theoretically, this might be the most appropriate method for accounting of ESOPs. ‘But practically, this might not be the most feasible option. This is because, if the market price of the equity shares goes down later, a question may arise whether such downfall also is to be recognized, by debating the share premium account, with the corresponding credit to Employee Compensation Expense (or to profit and loss account). It is also to be noted that only in the respect of equity shares, market price would be reflected in the books. The major portion of the equity shares would be continue to be stated at the actual price.’34 4.3.3. FAS 123: As per FAS 123, equity instruments issued to employees and the cost of the services received as consideration shall be measured and recognized based on the fair value of the equity instruments issued. 35 The portion of the fair value of an equity instrument attributed to employee services is net of the amount, if any, that employees pay for the instrument when it is granted. The objective of the measurement process is to estimate the fair value, based on the stock price of the grant date, of stock options or other equity instruments which the employees become 32 33

Ibid at p.155-156.

Supra note 30 at p.119.

34

Id.

35

Ibid at p.120.

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entitled to when they have rendered the requisite service and satisfied any other conditions necessary to earn the right to benefit from the instruments.

It is the view of the researchers that the Accounting Policies for ESOPs be reformulated in consultation with the ICAI. The ICAI, rather than SEBI should then issue fresh guidelines and end the confusion regarding the method to be used for determining the fair value and the entries to be passed in the books of account.

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Part III 5.0. Case Studies 5.1. Infosys Technologies Limited Anunay Shahi, bli912 & Rahul Sharma, bli950

5.1.1. Fact File Infosys Technologies Ltd., a 10,000-employee company, provides consulting and IT services to clients globally serving as partners to conceptualize and realize technology driven business transformation initiatives.36 Locations Corporate headquarters: Bangalore, India US headquarters: Fremont, CA Worldwide offices: Argentina, Australia,

Belgium,

Canada,

France,

Germany, Hong Kong, India, Japan, the Netherlands, Singapore,

Sweden,

Switzerland,

United

Kingdom,

United Arab Emirates and United States Employees

10,000

+

Main officers of the company Chairman of the Board and Chief Mentor: Managing Director, President and CEO:

Narayana NR Murthy Nandan M Nilekani

Summary Financials For the financial year ending March 31, 2002 US GAAP Revenues: $ 545 million Net Income after taxes: $ 164.4 million Earnings per ADS: $ 1.24 (diluted) Total assets: $ 471.1 million Cash and cash equivalents: $ 210.4 million Indian GAAP Total Income: Net profit after taxes: Earning per share (Rs. 5): Total assets:

36

Rs. 2,603.59 crore Rs. 807.96 crore Rs. 121.37 (diluted) Rs. 2,080.31 crore

www. i n f o s ys . c o m v i s i t e d o n 1 5 t h S e p t em b e r , 2 0 0 2 .

Employee Stock Option Plans: A Study Labour Law I

Cash and cash

16

Rs. 1,026.96 crore

equivalents: Key milestones Year of Incorporation: 1981 Became a public limited company in India: 1992 ISO 9001/TickIT Certification: 1993 Attained SEI-CMM Level 4: 1997 Listed on NASDAQ: 1999 Crossed $100 million in annual revenues: 1999 Attained SEI-CMM Level 5: 1999 Crossed $400 million in revenues: 2001 Crossed $ half a billion in revenues: 2002

5.1.2. The ESOP Scheme of Infosys Types of Schemes Infosys has had two schemes for ESOPs. In the beginning, the “first scheme” was introduced in the year 1994, which ended in the 1999. Under the “first scheme” the employees were vested with an option 37 to purchase the shares of the company at a pre-determined rate of Rs. 100. Under the “first scheme” 10% of the options could be exercised after 1 year, 20% after the 2 years, 30% after 3 years and 40% after 4 years.

However, since 1999 the “first scheme” has been discontinued and the employees under the new scheme are now vested with an option to purchase the shares of the company at the “fair market value of the shares” 38 on the day the option is granted to the employee. As was the case with the “first scheme”, even under the prevailing ESOPs scheme 10% of the options can be exercised after 1 year, 20% after the 2 years, 30% after 3 years and 40% after 4 years.

People eligible for ESOPs In Infosys Limited all employees and not only the managerial staff can be given ESOPs. Previously, the company policy was to grant ESOPs only to those people who stayed in the company for 5 years. However, now even people joining the Company are given these options. In fact, Mr. Kshitij Kumar, Project Manager, Infosys is now of the view that almost all the employees in Infosys have ESOPs, though the quantum may vary.

37

T h i s r e f e r s t o t h e p r o c e s s b y wh i c h t h e e m p l o ye e i s g i v e n t h e r i g h t t o a p p l y f o r t h e s h a r e s of t h e c om p a n y a g a i n s t t h e o p t i o n g r a n t e d t o h im i n p u r s u a n c e t o E S O S .

38 T h i s i s t h e r a t e a t wh i c h t h e m a x i m u m a m o u n t of s t o c k i s t r a d e d o n t h e d a y i n question.

Employee Stock Option Plans: A Study Labour Law I

17

Cash Less Stock Options Scheme Previously, the Infosys company’s ESOPs used to be a cash less scheme. In a cash-less stock option scheme the employee is not offered the actual ownership of the shares. Instead, the employee is provided with an amount, which is equal to the difference between the prevailing market price and the discounted price of the share.39 However, the Guidelines issued by SEBI have now altered this position and the same can now not be done.

Granting of ESOPs ESOPs in Infosys Limited are granted on the basis of performance. There are three routes whereby ESOPs are granted in Infosys Limited. These are divided into the following categories.

1. Grant by Chairman – Certain people in each grade of the company are identified on the basis of their performance and are known as the ‘pillars’.

These ‘pillars’ are granted stock options from the chairman’s quota.

2. Grant by Department – Similar to the chairman’s quota, each department also has a quota out of which options are then granted to people who are identified for their performance by each department head.

3. General Grant – On the basis of their performance, which is evaluated on the basis of a criteria evolved by the Human Resource Department, all employees of the company can also be granted options out of a general quota.

Since, ESOPs in Infosys Limited are performance based people on the same managerial post have differing amount of stock options.

Bonus Shares Previously when Infosys Limited declared a bonus issue, the bonus share were vested immediately with the Employee, while the corpus was still left locked in the company. However, with the stock market on a downswing and ESOPs “backfiring”40 Infosys Limited does not issue bonus shares and instead a ‘split’ is done.

Revoking of Grant 39 40

T h i s s c h e m e wa s a l s o a d o p t e d b y L a r s e n a n d T u r b o .

A t e r m u s e d b y M r . R a j n i s h T h a k u r , T e c h n i c a l A r c h i t e c t , I nf o s ys .

Employee Stock Option Plans: A Study Labour Law I

18

Infosys Limited has retained the power to revoke the option granted to the employees in case the employee decides to leave the company or is terminated or discharged from the company.

American Employees All the employees of Infosys Limited in United States are given the option to subscribe to the American Depository Receipts of the Company. This is a ‘cash-less transaction’ and the employees are just paid the difference as the American Law allows for the same.

Analysis The Indian Corporate Law favors the interests of shareholders over the interests of other stakeholders -'the focus...is profit maximization for the owners of the corporation'.41

Now, a company has multiple stakeholders, namely 'workers,

managers, creditors, suppliers, customers and other members of the community' 42, whoever the largest homogenous group of stakeholders for a company are usually the employees.

In the field of corporate law there has been a growing debate over the conflict between a company's obligations to its shareholders and to its stakeholders. 43 This debate can be best described in the form of a spectrum suggested by Adam Reynolds.44 Pluralism

Enlightened Shareholder Evaluation

Owner Focus

Stakeholder Primacy Spectrum At one end of the spectrum is a 'pluralist' view which mandates that a board should accommodate the needs of all parties that may be affected by its decisions, the shareholders being just one of these groups. At the other end of this spectrum is the proposition that a

41

Avtar Singh, Company Law, 2001 at 224.

Ibid at 225.

43 J o s e p h W ein er , ' T h e B e r l e - D o d d D i a l o g u e o n t h e C o n c e p t of t h e C o r p o r a t i o n ' (1964) 64 Columbia Law Review at 1458.

44 A d a m R e yn o l d s , ‘ D o E S O P s s t r e n g t h e n em p l o ye e s t a k e h o l d e r i n t e r e s t s ? ’ ( 2 0 0 1 ) 13 Bond LawReview at 27.

42

Employee Stock Option Plans: A Study Labour Law I

19

company, through its directors, should act to the exclusive benefit of its shareholders.

The debate over the conflict between a company's obligations to its shareholders and to its stakeholders treats employees and shareholders as two distinct groups. However, Infosys Limited has sought to blur this distinction and almost all the employees in Infosys Limited are also the shareholders of the Company. In fact, Infosys Limited has implemented the ESOP programme as part of an organizational philosophy, which seeks to motivate and recognize employee excellence.

However, the ESOP scheme does have certain connotations for the labour management/owner relationship. This has been analysed under the following heads: Influence in Shareholder Meetings Small groups of shareholders have the right under the Companies Act, 1956 to call shareholder meetings and propose resolutions.45 Thus, the Companies Act, 1956 allows minority shareholders, like employee groups, to be heard. However, in practice it is questionable whether employee shareholder would act against their own board given that it could adversely affect their personal wealth. In fact, none of the people interviewed by the researchers were inclined to ever exercise their influence in a shareholder meeting.

Employee Shareholder as Class Members Employee shareholders, though not named as a specific class, form a distinct class of shareholders in many firms as the ESOPs generally carry ‘restricted rights’ regarding votes and transferability. However, the same is not the case in Infosys Limited and hence, cannot claim benefit of the provisions relating to ‘class members’ in the Companies Act. Labour Turnover One of the main aims of the ESOP programme of Infosys Limited was to reduce labour turnover46 and to ensure that valuable employees do not leave the company. In fact, the ‘first scheme’ of Infosys Limited was successful in retaining 45

Avtar Singh, Company Law, 2001 at 228.

A s n a r r a t e d t o t h e r e s e a r c h e r s b y M r . K s h i t i j K um a r , P r o j e c t M a n a g e r , I n f o s ys Limited.

46

Employee Stock Option Plans: A Study Labour Law I

20

employees and reducing labour turnover for a period of atleast 5 years during which the stock options were locked in the company.

However, due to the dotcom boom and the resultant rise in the share prices of Infosys Limited the ESOP policy of Infosys Limited “backfired”. This was due to the fact that the employees who received the stocks at the pre-determined rate of Rs. 100 per share became millionaires overnight and thereafter either left the company or retired. Thus, many of the people who had joined the company in the years 1994, 1995 and 1996 and had exercised their options during the period of the dotcom boom have now left the company.

This is a serious problem and in fact, in the Extraordinary General Meeting the Board of Infosys Limited was asked to explain what steps were being taken to either avoid or cover the loss which might arise in the year 2004, when the people who were granted the stock options under the “first scheme” in the year 1999 are free to sell off their stock.

Moreover, the new ESOP scheme of Infosys Limited is not as lucrative as the “first scheme” and hence, it has also failed to reduce labour turnover, especially since salaries in Infosys Limited are lower than the average salary of the Industry. 47

Motivation Since the ESOP scheme in Infosys Limited is “performance based” the same has acted as a great motivator for the employees. In fact, all the employees, especially the younger generation of employees, considered ESOPs to be more important than the more traditional forms of remuneration such as salary and bonus and considered them to be a reward for their work and pictured themselves as having a stake in the performance of the company.

Thus, the ESOP scheme of Infosys Limited has been an excellent way in which the contribution of the employees has been recognized by the firm thereby giving the employees a feeling that they have a definite stake in the performance of the company and has hence, reduced the tension between labour and management.

However, with the Stock Markets taking a downturn and becoming more unstable, 47

V i e w e x p r e s s e d b y M r . K s h i t i j K um a r , P r o j e c t M a n a g e r , I nf o s ys L im i t e d .

Employee Stock Option Plans: A Study Labour Law I

21

ESOPs are now losing their importance in Infosys Limited and the people at Infosys are now trying to evolve new ways to reward and motivate employees.

5.2. Aztec Software and Hutch India Michael Sailo, bli935 An ESOP as per Miss Judy of Aztec Software is basically a qualified, defined contribution plan that invests in the stock of the employer company. Because of the reluctance of both Ms. Judy and Mr. Ajit Kumar of Hutch India to divulge company information because of strict policy, it has been an almost impossible task to glean any information out of them. Both individuals were not even willing to divulge as to when ESOPs stated in their respective companies. But since these two companies in question are fairly new, it would be possible to infer that ESOPs have had a short life in their respective companies. Mr. Ajit claims that ESOPs are useful in order for companies to get required finances since ESOPs can be used to borrow money. To do so, according to him, 'the company issues new shares and sells them to the ESOP in a leveraged transaction using the proceeds from the sale to finance acquisitions or to refinance debt.' both individuals were not willing to even give out information on as to the percentage of the company stocks which were dedicated to ESOPs. However on the other hand, Ms. Judy willingly stated that at the end of their term with the company or retirement, the ESOP benefit could be taken in payments of monthly installments or in a lumpsum. She also stated that most employees on leaving their companies preferred to take the amount in a lumpsum. Mr. Ajit was of the belief that ESOPs have relatively improved the work culture of the employees, this fact was reiterated by Mrs. Suman who works in the HR Department of Infosys.

To this end, it is well known that even the lower grade employees of Infosys have been given shares. This undoubtedly improves the work culture of the employees since they too know that they have a stake in the company. But here again, Mrs. Suman wasn't willing to give away any information except general information and ideas on what ESOPs are. Here again, she stated company policy, but with regard to the reason why employees work harder once they have a stake in the company, the reason is magnifianly clear. A person for obvious reasons would put in much more work if he has a stake in the work that he is doing.

The main problem facing the researcher while doing fieldwork is that most organizations, which he has approached, have been unwilling to give out information on the working of ESOPs with regard to their companies. However, all of them have

Employee Stock Option Plans: A Study Labour Law I

22

been kind enough to divulge information, i.e. general information. Most of this general information has been incorporated throughout this project in the form of theory and other material.

5.3. Transport Co-Operative Society Sandipto Das Gupta, bli953 & Soumitro Mukherjee, bli965 Transport Co-operative Society, Koppa is a co-operative started as a breakaway enterprise form the erstwhile Shankar Transport Company (Pvt.) Limited. The erstwhile Transport Company was started in 1957 by late Sri.M.S.Gowda. Later during the 70’s and the 80’s, the unit was being managed by the Aroor family. During those years, Shankar Transport Company was considered to be one of the most efficient bus services in Shimoga, Chikkamaglur and some parts of South Kanara, comprising nearly of 85 routes. The company employed around 350 workers.

However like most movements, which are influenced by the economic and social systems operating alongside it, the movement that brought about the genesis of Transport Co-operative Services was no different. Low wages, a rising cost of living, a pay hike in Gajanana Transport Company, and such other factors brought about an awakening among the workers and accordingly, they resorted to a strike on July, 1987. Though the strike was mostly peaceful and the workers mainly resorted to slogan-shouting and were looking for peaceful deliberations, the management of Shanker Transport Company reported that during the strike the workers damaged many buses, they cut break pipes, punctured the radiators, broke the glasses and assaulted the loyal workmen, pelted stones at the buses and in the process various passengers were injured.48 The management dealt with the strike very harshly by removing 27 workers who were in the forefront of the strike. The company also suspended certain workers and initiated various other tactics to crush the deviation, if any. The strike did not produce any desirous results, the reason being quite obvious that there being a distinct lack of effective leadership. As earlier Shankar Transport continued paying lower wages than those fixed under the Minimum Wages Act. It is known from present members of TCS that the minimum wages fixed by the Government for a bus driver at that time was Rs.950. however the salary statement of Shankar Transport 48

Q u o t e d o n t h e b a s i s o f L e t t e r N o . 8 1 9 , d a t e d 1 9 t h N o v em b e r , 1 9 9 0 s i g n e d b y S r i . A . M a n o h a r a R a o , M a n a g i n g D i r e c t o r of S h a nk a r T r a n s p o r t C o m p a n y L im i t e d .

Employee Stock Option Plans: A Study Labour Law I

23

Company as on 13.12.1990 shows that Rs.606 had been paid as minimum wages for drivers.

The agreement pertaining to salary and other terms and conditions entered between the workers and the management during 1987 ended on 30th June, 1990.

Hence, on 1st July, 1990, the Workers Union submitted the Charted of Demands to the management. However in spite of many repeated requests and negotiations, the management of Shankar Transport Company failed to respond positively to the workers’ demand. Finally workers led by Sri.Chikke Gowda, supported by the All India Trade Union Congress (AITUC) and contemporary revolutionaries like Sri.B.K.Sunderesh and Sri.Renukaradhya, began to fuel the workers movement with renewed vigour. However, initially nothing positive came out from various demonstrations such as the “Demand Week”, or the “Hunger Strike” and many rounds of discussions held between the workers and the management. Even the conciliation efforts conducted by the Labour Commissioner, Bangalore and the Assistant Labour Commissioner, Chikkamangalore district under s.12(1) of the Industrial Disputes Act, 1947 failed to settle the dispute between the management and the workers.

Lastly, the majority of workers affiliated to Chikkamangalur District Transport and General Mazdoor Sangha, supported by the AITUC and other organizations started a total strike on the 15th of December, 1990. This strike paralyzed the whole bus transport in and around the Malnadu Region affecting bus services of nearly eighty routes of Koppa, Kalasa, Balehonnur, Sringeri and NR Pura. The strike continued, but neither the management nor the government showed any positive signs in resolving the issue. Sri Aroor Manohar Rao, the then Managing Director of Shankar Transport Company rejecting the demand of workers announced to the Press that “….it is extremely difficult to run buses in the present situation. The catastrophe of Gulf War is mainly responsible for the shortage of diesel and petrol.

The fuel prices having shot up and therefore there is no visible future in this industry”.49 The peaceful strike lasted 53 days, and there were many demonstrations. On 6th February, 1991, the whole Malnadu observed protest and Bundh in support of the

49

V i d e a p r e s s s t a t em e n t i s s u e d b y t h e m a n a g e m e n t of S h a nk a r T r a n s p o r t C o m p a n y i n U d a ya v a n i o n 8 . 2 . 9 1 .

Employee Stock Option Plans: A Study Labour Law I

24

workers movement. Support organizations like AITUC, Students Federation of India (SFI), All India Youth Federation (AIYF)- all supported the cause of Shankar Transport Employees Union. Sri Chikke Gowda, the then leader of Shankar Transport Employees Union and General Secretary of Chikkamaglur District Transport and General Mazdoor Sangha emerged as an effective leader channelizing the movement of the workers.

However, the management was very firm on its stand and not prepared to pay the salary scale of the other transport companies. After various internal deliberations, the management declared a lock out on 07/02/1991 and retrenched all the workers.

Within few days of announcing the lock out, the management of Shankar Transport Company surrendered 67 permits of 80 routes to the Government.50 On hearing about the shocking news of the lockout the Transport Union convened its General Body Meeting and decided to withdraw the strike. Accordingly, on 08/02/1991, the Workers Union submitted the Strike Withdrawal Notice to the management but the management was adamant on getting rid of all the striking workers.

Now, it had become imperative on their part to strive hard to save their jobs.

Initially, the workers explored all possible avenues to get the transport unit run by the management. It was only when they failed in their efforts to find a solution, that the workers volunteered to run some buses. A fraction of employees decided to mobilize their compensation amount and sought permission to run buses on a co-operative basis. Accordingly, in the Meetings of Regional Transport Authority held on 11/02/1991, under the Chairmanship of Dr.S.Subramanya, the Employees Union of Shankar Transport Company got six permits and permission to run seven buses on a co-operative basis and also sought permission to run 35 to 40 buses. All the 273 workers got their compensation amount from Shankar Transport Company out of which a break-away group consisting of 130 workers agreed to invest their compensation amount of Rs.4.85 lakhs to strengthen Transport Co-operative Society.

Shankar Transport Company was split into four transport companies. Apart from 50

Transport

Co-operative

Society,

they

were

Ravishankar

Transport,

V i d e p r e s s s t a t em e n t i s s u e d b y S r i . A ze e z S a i t , M i n i s t e r f o r T r a n s p o r t , K a n n a d a Prabha on 21.01.1991.

Employee Stock Option Plans: A Study Labour Law I

Shambushankara

Transport,

Udayashankara

Transport

and

25

Navashankara

Transport. All these four units agreed to provide employment to 100 odd employees.

Hence the Transport Co-operative Society started its operation in the selected routes of Malanadu region from 8th March, 1991. The Union leader and former mechanic of Shankar Transport Company Sri Chikke Gowda was made the Chief Promoter along with other 10 workers as Co-promoters. Later on May 16th, 1991, Transport Co-operative Society got registered with the Joint Registrar, Chikkamaglur and started its efficient operations and various expansion programs.

At the beginning an average of 125 workers who shared the rehabilitated amount became the members as well as workers and looked after administration. But purchasing buses from the owner of the former company with an average amount of 12 lakhs the society came into existence on 08/03/1991, in which an average of 36 workers looked after departmental works, while others enterprised in different fields, with the net profit gained from the established society new buses were purchased, the members who were working impersonally joined as a team to lay the foundation of the co-operative society.

Since the workers of the society had their vast experience only in working, the supplement to administration was lacking. However, this drawback was overcome by the Co-operative Department, Transport Dept. and with the help from the localities who helped the Co-operative to get a clear understanding of the Rules and Regulations in the area. In relation to all these aspects the government in 1993-94 awarded Rs.1 lakh recognizing the society as a Special Co-operative Society.

Other than good salary to its workers, the society had extended its business with the net profit gained over the years and began to stabilize its foundation for a more secure and brighter future.

5.3.1. Transport Co-Operation Society (TCS), Koppa: A Profile Bus transport is of vital importance for the passengers especially to the Malnad area more so owing to the absence of railway transport. Also since the region is hilly, passenger rely heavily of bus transport. TCS, Koppa primarily aims to provide quality transport facilities to the passengers of the Malnad region and thereby benefiting society and the workers working in the society.

Employee Stock Option Plans: A Study Labour Law I

26

Number Of Buses Owned A study of transportation services offered by TCS from the year 1991-2001 reveals the spread of its operations over Malnad region. On 16/05/1991, the company started its operation with 6 buses, which were purchased from the erstwhile company. In 1992 it rose to 14 buses and by 2000 this number had reached a staggering 63 buses.

70 60 50 40 30 20 10 0 1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 200092 93 94 95 96 97 98 99 2000 01 Number of buses owned by TCS, Koppa.

Area Covered The area in which TCS is situated is the hilly regions of the Malnad area. This area is not covered by railways, and therefore buses are the only mode of transport for the inhabitants of these interior villages. TCS began modestly with only six old buses and in their first year covered a total of only 9,46,857. Slowly they expanded their services and covered the remote areas in Shimoga, South Canara and Chikmagalur districts in the Malnad region. Now they cover almost whole of these areas and their buses ply to centres like Agumbe, Agalgandi, Balehonnur, Bidargodu, Bannur, Bhadravati, Birur, Ajjampura, N.R.Pura, Uttaameshwara, Melpal, Manipal, Udupi, Tharikere, Lakkavali, sagara, Hosa Nagara, Thirthahalli, Devangi, Gadikallu, Kammardi, Aldur, Chikmagalur, Shimoga, Umblebylu, Hariharpura, Kigga, Sringeri, Jayapura, Narvey, Kottigechara, Konandur, Mandagadde, Malandoor, Muttinakoppa, Shettykoppa, Kuduregundi, Karkala, Hebri, Basvani, Rippenpete, Kundapura, Mastiketta and others. Thus, from a modest beginning, the company is now the major

Employee Stock Option Plans: A Study Labour Law I

27

player in the bus transport sector in this region, and approximately hold 63 percent of the market share in the region. 51 In the year 199-2000 the company buses covered a total of 43,92,736 lakh miles, a growth of coverage of almost five times is just ten years.

Table: Total miles covered by TCS buses over the years.

Year 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000

Total Distance Covered (in Lakh Miles) 9,46,857 11,04,600 13,46,485 15,04,895 19,72,620 27,33,850 38,63,160 44,44,585 42,92,736

Profits TCS have been making constant profit from its very first year, bellying the claim of the former owners of the Shankar Transport Corporation that it was difficult to run a transport service in th eregion. The following graph shows the profits of the company over the years.

14000000 12000000 10000000 8000000 6000000 4000000 2000000 0

Net Earnings

1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998- 1999- 200092 93 94 95 96 97 98 99 2000 01

Recruitment The co-operative society which began with a work force of 126 employees has 283 employees till date.

YEAR 51

Number of Employees

T h i s i s h o we v e r b a s e d o n t h e e s t i m a t e of t h e m a n a g e m e n t of K o p p a a n d t h e y c o u l d n o t g i v e a n y p r o p e r m a rk e t s t u d y i n s u p p o r t o f i t . T h e r e h a v e b e e n a p a s s e n g e r s u r v e y o u t o f a s a m p l e of 6 0 p a s s e n g e r s wh i c h s h o we d t h a t n e a r a b o u t 6 6 % o f t h o s e s u r v e ye d u s e d T C S b u s e s f o r t r a v e l l i n g . T h e e x t r e m e l y s m a l l s am p l e s i ze a n d t h e f a c t t h a t a l l t h e r e s p o n d e n t s we r e f r o m t h e s a m e a r e a m a k e s t h i s a n u n r e l i a b l e s u r v e y.

Employee Stock Option Plans: A Study Labour Law I

1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01

28

36 88 119 138 146 200 205 196 220 232

The society has thus provided employment opportunities with the Malnad region by employing people in various capacities such as drivers, conductors, mechanics, cleaners, technicians, etc. The society has also employed various persons in non-technical areas such as clerks, accountants, challan managers. The society provides sufficient amount of salary to the workers every month.

Share Arrangement Under the constitution of TCS, only an employee can become a member.

Membership rights are not automatically conferred upon the employees since, as TCS President Mr.Chikke Gowda puts it, a member has to become a part of the ethos and culture of TCS before he can become a member. The 124 employees who had joined the society at its inception were granted membership rights. Hence before admitting any new member into the society it wants to ensure that they shall understand the responsibility of being a member of the society. Therefore the policy that has been adopted by TCS is that after 4 years of service at TCS a person is automatically eligible to become a member of TCS, Koppa by purchasing its shares which are valued at Rs.5,000/- per share and there is no cap upon the numbers of shares that may be purchased by a member. However the problem of controlling shareholding is taken care of by the simple policy that is followed at TCS that being “one member one vote�. Therefore even if a employee buys plenty of shares, it does not give him any extra power with regards to the control of the company.

Table:Sources of Long Term Capital for TCS (All figures in Rs. Lakhs) Year 1991-92 1992-93 1993-94 1994-95

Share Capital Members Government 5.00 4.86 4.82 4.47 -

Deposits 4.36 2.38 1.55 1.81

Employee Stock Option Plans: A Study Labour Law I

1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01

6.70 8.09 8.04 7.89 8.09 8.79

2.00 2.00 2.00 2.00 2.00 2.00

29

2.64 5.76 8.34 12.67 10.82 17.05

There are five classes of shareholders: A Class: Drivers and Conductors B Class: Technicians C Class: Clerical Staff D Class: Government E Class: Suppliers and other related non-employees F Class: Retired employees E and F class shareholders have no voting rights.

Share capitals are the main source of capital of TCS when it started. Atleast for the first year of their operation, it was the only capital that they had as no bank was ready to give them any loan. In western countries, where ESOPS is a recognised strategy of trade unions, bank loans for ESOPS, or a employees buy-out is rather common and banks are willing to forward such loans. IN Indian however the banks were rather skeptical to forwards any such loan. Therefore only after an year of showing was TCS able to get loans from the Banks. However the percentage of share as part of the total share started to decline during the end of nineties. The reason for this being that the company was going through some troubled times and there were also some problems regarding the management. This made the shareholders, especially the E and F class shareholders loosing their faith on the company and selling their shares. The company took note of this and therefore took measures to restore shareholder’s confidence. Following those measures, the amount of share capital began to rise as will be evident from the following table.

Wages The wages have been one of the most outstanding results of the new arrangement. The very year TCS was formed, there was a major increase in wage across the board from the wages that was last drawn by the workers as an employee of Shankar Transport Company. This can be seen from the following table.

Table : Comparative Gross Salary of Shankar Transport Company and TCS in 1991.

(All amounts in Rupees)

Employee Stock Option Plans: A Study Labour Law I

Category

30

Gross Salary in Gross Salar y in Difference Shankar T CS T ransport 1991 Company 1991

1. Office Staff Senior Clerk

1,227

1,256

29

Junior Clerk

928

1,042

114

Attender

898

1,016

118

Office Boy

746

866

120

2. Mechanic 3.Checking Staff 4. Conductor 5. Driver

930 861 801 831

954 1,006 961 1,060

24 145 160 229

These wages have been steadily increasing. When asked whether there are any issues regarding wage increase, one of the members of the board of directors answered with a smile that, “why will we oppose a pay hike, it will benefit us also.� On a more serious note they informed us that the Board decides on wages every year on the basis of how much capital the company will need for expansion and further investment. The increase in salary over the last 11 years have been phenomenal keeping in mind that TCS operates bus services in interior hilly regions where the profitability is not anything great.

Table: Increase of Wages from 1991 to 1997 Category

Salary 1991 (in Rs.)

Salary 1997 (in Rs.)

Percentage of Growth in 11 years

Senior Clerk

1,256

3,043

142.28

Junior Clerk

1,042

155.5

Attender

1,016

Office Boy 2. Mechanic 3. Checking Staff 4. Conductor 5. Driver 6. Watchman Average Increase

866 954 1,006 961 1,060 700

2,663 2,992 2,211

1. Office Staff

2,760 2,666 2,638 3,006 1,707

187.6 155.3 189.3 165 174.5 183.58 143.5 166.34

The significance of the wage given by TCS can be better understood if it is compared with the wages given by a competing bus service in the same route. We

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could not get hold of present day data and therefore had to rely on the 1997 wage rate in Hanuman Transport Company, one of the major private sector players in the market. The following table will give a comparison of the wage rates in Hanuman Transport and TCS in 1997.

Table: Comparative Gross Salary between Hanuman Transport Company and TCS during March, 1997 Category

1. Clerk 2. Attender 3. Office Boy 4. Mechanic 5. Checking Staff 6. Conductor 7. Driver 8. Watchman

Gross salary per month in Hanuman Transport Company 1997 (in Rs.) Minimum Maximum 1,622 2,260 1,268 1,730 1,268 1,730 1,568 2,076 1,586 2,090 1,586 2,090 1,586 2,250 1,268 1,560

Gross Salary per month in TCS 1997(in Rs.) Minimum 1,324 N.A. N.A. 1,667 1,936 1,165 1,404 1,092

Maximum 3,237 2,932 2,211 2,898 2,680 2,638 3,312 1,707

Note: The gross maximum salary in Hanuman Transport is with regards to employees who have worked there for 20 years or more. On the other hand TCS was just a 6 year old concern at the time of collecting this data.

Along with higher wages TCS also gives several benefits to their employees.

These include: Dearness allowance Bonus Dividend Uniform Provident Fund Special Allowance Medical Allowance Gratuity Earned Leave Casual Leave National Holidays

Based on cost of living index. It is presently more than Rs.100 and increases twice a year.

The society has been continuously paying 16% during 2000-01 Based upon the profit earned per year.

Dividend announced at the last AGM was 16%.

3 pairs for 2 years 12% by employees, equal amount by the society.

Based on the performance Rs. 500/- per year or actual expenses whichever is lower Paid during retirement One day for every 11 days of work in the previous calendar year 12 days in a year 10 days leave on important national holidays and festivals

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Free Pass Facility Personal Insurance and Accident Compensation Group Insurance Financial Assistance to children for Academics Free pass facility to the children for Academics Special Deposit Scheme Loan Facility

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2 per month to all family members Rs.80,000 compensation on death Rs.62,000 on death Rs.100 to Rs.500 per year based on course and the class of the child To travel to their educational institution A minimum deposit of Rs.2,000 becomes Rs.4,000 within 50 months On the basis of the salary earned by the employee

5.3.2. Employer Employee Relationship Another outstanding result of this endeavor have been the employeeemployer relationship. In TCS all the traditional notions of employer-employee relationships, which are generally understood in terms of constant adversarial conflicts and rivalry do not apply. This is but only natural in a company where the lines of employee and employer is blurred as the owners are also employees.

However, what could have happened is that the part of the employees which undertook the managerial duties could have misused them and have become defacto “employers�. However, the management, till now, have remained exceptionally committed. All the managerial staff still perform the duties for which they are primarily before performing their managerial duties. E.g., Mr. Chikkegowda puts in his hours as a mechanic apart from performing the duties of the president.

They also do not get any extra benefits, financial or otherwise for holding these posts. The only privilege they get is traveling allowances when they go out of station for any work of the company.

There have been hardly any labour problems in the company. The grievances of the workers can be brought before a ten-member grievance committee which comprises of a representative from each segment of the workforce and are elected by the workers themselves. Till date, the committee have been able to take care of every single problem. Consequently there have been no legal action against the company till date from the side of the workmen, and the question of strikes and any other major agitation doesn’t even arise.

The workers at TCS are constantly reminded of the fact that it is their company and that they have a role to play in its running. Regular fortnightly meeting with workers are arranged to keep them informed of the functioning of the company

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and the important decisions taken. They are also educated about the policy and objective of the company and how it is different from the other companies. This helps to keep a high motivational level amongst the workers. This is one of the reasons Mr. Chikkegowda stated when we asked how he manages to remain profitable even after giving such high wages. It is because of an extremely high sense of commitment amongst workers and the resultant growth in productivity of every worker. There is also a big cutdown on what is known as mechanical leakages in transport business, meaning that the quality of the work has also improved to a large extent. The sense of pride in the workers about their company and the unique way in which it is run is evident from the conversation one has with the workers.

General Body Meetings are held in the month of August every year in the company itself and the attendance is 100%. Important decisions regarding the company are taken in this meeting. The Board of Directors, which is also formed with employees only, takes the tentative decisions. The GBM thereafter ratifies and if needed modifies these decisions. It also chooses the president and other managerial post holders. Though there are provisions for election to these posts, till today they have been able to stick to unanimous choices.

5.3.3. Service Provided The fares charged by TCS are in par with the fares charged by other private operators. However TCS fulfils its commitment to the society by providing several benefits to the passenger which is extraordinary for a private bus service and even the state owned transport service, KSRTC. TCS provides for free bus rides for disabled people. Regular schoolgoing children are provided with a pass which is subsidized to the extent of 70% of the fare.

Senior citizens are also given a 50% discount on their tickets.

5.3.4. Problems Faced By The Company Problems of Finance Initially, the society faced grave problems of finance since it was primarily a workers co-operative society. The workers had invested their life time earnings from the previous company and had pooled it as resources for TCS. However although since over time the problem of finance is not as grave as it was at one point of time, yet the society is constantly in need of funds to expand the business and buy new

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buses. The bank loans are taken from D.C.C i.e. the District Central Co-operative Bank. Since it is a registered co-operative society, TCS can only approach CoOperative banks for all sorts of financial dealings, including loans.

Lack of Professional Management The society has been exclusively run by the workers and no professional help has ever been sought at any point of time. However this worker driven management is often a problem since none of the workers including himself have any experience of managing a business. However Mr. Chikke Gowda gives the following reasons for not recruiting external managers. Firstly, the wages that they can offer are low because the business as per him has yet not established itself. Secondly, experts in the transport industry are general management are difficult to get in the area where the society is established. Finally, he says that the society has a history which is shared amongst the workers and only they can be truly trusted with its working and an outsider cannot be made a part of such a organically developed institution.

Bad Condition of the Roads Since the operation of the society is primarily in the Malnad region which is a hilly region, the roads are very often in a bad condition primarily due to the rains. This causes considerable difficult for the society to ply buses in remote and interior areas however this has still not stopped the society in plying buses in these otherwise inaccessible areas in spite of the costs that the society has be bear in terms of maintenance and wear and tear of its vehicles.

Dissatisfactory Collections The collections of the bus service is very low on weekends and more so Sundays. Also there is stiff competition that the society has to face from rival private operators who have greatly eaten into the market share of TCS. The private companies often get an upper hand over TCS by paying bribes to the officials and thereby obtaining more favorable timings and routes.

5.3.5. Lessons TCS, Koppa is a story of an experiment of running a company which has become brilliantly successful and the lessons from this are many. But the one which struck us the most is that this can be a very good way reviving sick industries and as well as privatization.

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Sick Industries One of the major reasons for failure of industries (but which does not get as much mention as labour inflexibility) is lack of good management. Often this is not just incompetence of the management, but a devious plan for personal enrichment.

Often the management is interested in taking the fund out of one of his concerns and into some other concern. As a result the first concern suffers and the management may declare it sick and try to close it down Sometimes the companies are brought by real estate speculators from the genuine entrepreneurs. They are not interested in running a business, but somehow sell the assets of the company and make a one time profit. The corporations remain profitable in all these cases, but just because of management who are interested in some personal benefits of their own, the company suffers. This has been a major reason for the failure of the Bengal jute industry in Greater Calcutta area. Contrary to popular perceptions, jute still has a considerable international market, and considering that India is one of the few countries which has a full fledged jute industry, the industry should be doing pretty well. However, what can be seen in the Greater Calcutta area is that the whole industry has become sick and are facing large scale closures. This is because of the transfer of all these industries into the hands of traders who are all interested in the considerable real estate value of these old mills, and have tried their best to wreck the business so that they can sell them off. Faced with a stiff resistance from workers who rightly claimed that the mills can still make profit, the management resorted to even underhand techniques such as stealing the machineries at night and selling them off. The workers here have demanded that let them be handed over the shares in lieu of their provident fund amounts and they can run the mills profitably. The Koppa example can show the validity of their demand and how that can be a highly feasible way to revive the industry. The government, and the BIFR should therefore give a serious consideration to ESOP as an option of revival of a concern.

Privatisation ESOPs can be an excellent strategy for privatization. If the government is adament on their stand that it is not their job to run businesses, they should consider ESOPs as the first option for privatization. The reason for this is mainly two. Firstly, the reason for failure of most of the government concerns is incompetent or corrupt management. Since they did not have any stake in the concerns, the managers did not care to work hard for it and the only interest they took in it was how to fleece out the most during their tenure. As can be seen in Koppa, a worker’s management

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views the concern as one of their own and are highly dedicated and motivated for its benefit. As in Koppa they are not at all interested in personal gain, but the gain of the concern (they do not even get any extra salary for their post as managers). Secondly, there is a duty on the part of the government to maximize public good. In the present form of privatization, new private sector monopolies are created in place of the old public sector ones. This is benefiting only a handful of rich capitalists. However if the government undertook privatization through the means of ESOPS, the benefits will be distributed amongst all the lower middle class and middle class workers of the company, and their job security will also remain intact.

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5.0 Conclusion The concept of an employee having a stake more than his or her mere remuneration in the profits of a company has been a relative old management mantra that has metamorphosed into various dimensions and this is amply demonstrated by the present research paper. Since the theme of this research paper was Employee Stock Options (ESOP’s) the researcher’s chose to demonstrate this metamorphosis by conducting field work in two corporations where this concept of employee having a stake in the share of the company has seen starkly different dimensions. The corporations namely Infosys Ltd. and Transport Co-operative Services, Koppa are two examples of such variant patterns of management strategies that have emerged as an incentive for the employee to contribute towards the betterment of the firm.

Let us now compare the differences that lie with regard to the management and running of the two companies. Apart from the clear differences in the size of the two corporations, the first striking difference between the two corporations is that while in the former, namely Infosys Ltd. the shareholding is vested in various groups namely the promoters, shareholders through a public issue and employees who have acquired shares through ESOP’s. Thus the shareholders are vast and varied. On the other hand in the latter corporation namely TCS, Koppa, there are only employees who may become shareholders. Thus the controllers of the company all belong to one class and have similar concerns towards the company. Secondly, like any ordinary corporation the voting pattern is dependent upon the number of shares a person holds which invariably leads to a certain person or class of persons dominating the entire management and decision making process in the company.

This problem is rectified in the latter corporation whose voting policy simply stated is “one member, one vote” irrespective of the number of shares that a particular member holds. This ensures that even the President of the corporation cannot take decisions without the prior consent of the other members. This ensures that the concept of democracy in the board room is practically implemented which is otherwise inconceivable in a modern corporation.

The other very important difference between the two corporations is the incentive factor. While the concept of ESOP’s are explained in the first chapter of this research paper arose in circumstances where it was sought fit that an employee has more incentive in the betterment of the company. Thus while an employee of Infosys

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Ltd. sees his ESOP’s are a mere perquisite the stakes in the latter company as demonstrated by its history were far greater than mere perquisites since the existence of the company and their own existence was under threat in the cirucumstances wherein the corporations was formed. Thus having pooled in their independent resources in the corporation the existence of the firm and its longevity is a far greater incentive that a mere perquisite or an added advantage that may be given by a corporation offering ordinary ESOP’s.

Lastly, owing to a cumulative effect of the above-mentioned traits, the ideology of an employee working in a corporation such as Infosys Ltd. and TCS, Koppa is starkly different. While en employee in the former corporation sees the his own entity as being miniscule and separate from that of the corporation, an employee in the latter corporation sees himself as an integral part of the management and entity of the corporation. This ensures that the worker sees the corporation as his own corporation and the betterment of the corporation as his own betterment. Thus it puts the worker in the same controlling seat and frame of mind as the owner of the Infosys Ltd. and therefore the incentive for the worker in a corporation such as TCS, Koppa is far greater than that of an employee in Infosys Ltd.

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6.0. Bibliography A. Articles 1. A Response To Henry Hansmann And Other ‘Survivalists’”, 67 Fordham L. Rev. 957.

2. Adam Reynolds, “Do ESOPs strengthen employee stakeholder interests?” 13 Bond Law Review 27.

3. Alan Hyde, “The Kenneth M. Piper Lecture: In Defense Of Employee Ownership”, 67 Chi.Kent. L. Rev. 159.

4. And Implementation Of Employee Stock Ownership Plans: 5. Gina Marie Agresta-Richardson, "Employee Stock Ownership Plans: Uncertainties Plaguing the Duties of the ESOP Fiduciary with Respect to Voting and Defensive ESOPs”, 14 Akron Tax J. 91.

6. Gopal Chalam & Ganpati M. Nadkarni, “Tax Implications of ESOPs”, (2000) 160 CTR (Articles) at p.28.

7. Jeffrey M. Hirsch, “Labor Law Obstacles To The Collective Negotiation 8. Joseph Weiner, “The Berle-Dodd Dialogue on the Concept of the Corporation”, 64 Columbia Law Review 1458.

9. M. Krishnan, “ESOP Is Not A Perk-Retroactive Nature of the Finance Act, 2000”, (2001) 165 CTR (Articles) at p.250.

10. M.S. Prasad, “Guidelines for ESOPs under Income Tax Act – A review”, [2001] 45 CLA (Mag.) at p.76.

11. R L Sangani, “Finance Bill- Need for Clarification in Relation to Provisions Pertaining to Employees Stock Option Plan”, (2001) 166 CTR (Articles) at p.143.

12. Sachin Vasudeva, “Accounting for employee stock options”, 26(6), SEBI &Corporate Laws (2000) at p.118.

13. T N Pandey, “Taxability of Perquisite Relatable To Stock Options – No Relief in Budget 2000-2001”, 109 Taxman (2000) at p.77.

B. Books 1. Avtar Singh, Company Law, 2001.

2. Michael Poole, The Origins Of Economic Democracy, 1989.

C. Miscellaneous 1. Black’s Law Dictionary, 7th Ed., 1999.

2. Report of the Committee on ESOPs, www.sebi.gov.in/press/99135 report.html (Visited on 9th September, 2002).