Given the market turbulence in Hong Kong, is the timing right for Employee Share Ownership Plans (ESOPs)?
ESOPs were first introduced by Peninsula Newspapers in the US in 1956. Since then, ESOPs have been regarded as one of the classic methods to invigorate businesses and induce impetus for growth.
Put simply, ESOPs give part of the shareholding of the company to employees whose work is closely related to the development of the company. The purpose is to give employees a sense of ownership, thereby promoting the sustainable development of the company. ESOPs may take various forms, such as share options, restricted shares, or employee share purchase plans. Share options give employees the right to buy a certain amount of shares of the company within a future period of time at a predetermined price and under predetermined conditions, and the difference between the option exercise price and the market price is the value of the incentive. Restricted shares allot a certain amount of shares to employees, which will be vested in the employees by a specific date in future, and the market price of the vested shares is the value of the incentive. Employee share purchase plans give employees the right to purchase shares of the company in accordance with certain conditions, and the difference between the market price and the purchase price is the value of the incentive.
Crisis or opportunity?
So no matter which type of incentive scheme is offered, employees can only benefit if the share price goes up. But throughout the first three quarters of 2019, the Hong Kong stock market remained volatile. The Hang Seng Index rose steadily from early 2019 to April, accumulating a growth of 20%. It then tumbled after April. The US, Hong Kong and the Mainland of China (the Mainland) are leaders in the global IPO market, but IPOs in Hong Kong shrank both in volume and in value. Some to-be-listed companies, in particular large ones, have faced the challenges of a reduction in IPO price, a reduction in their capacity to raise capital and delays in their listing plans. Going forward, in view of the trade war between the Mainland and the US, the development trends of the renminbi and social events in Hong Kong, the outlook for the Hong Kong IPO and secondary markets remains uncertain. Under such circumstances, should listed companies still implement ESOPs?
With the increase in the number of listed companies in Hong Kong and the growing popularity of the concept of share ownership incentives, the demand for ESOPs among companies and employees is still strong despite the volatility of the market. In particular, with mixed-ownership reforms going on in state-owned enterprises in the Mainland, the offering of effective incentive schemes has become a key subject for consideration. The ‘Notice on Matters Related to Effective Implementation of Stock Ownership Incentives of Listed Companies Controlled by Central Enterprises’ issued by the State-owned Assets Supervision and Administration Commission in November 2019 brings in major improvements to the requirements regarding the form and method of share ownership incentives, offering price, amount of offer and approval procedures. Under the circumstances, I believe offering ESOPs will remain the trend.
When the economic situation is unfavourable and there is a lack of impetus for business growth, employees are easily disincentivised, and the problem of brain drain tends to arise. Under such circumstances, the introduction of appropriate ESOPs to set clear direction for corporate and personal development and provide benefits to core employees is a good therapy to give assurance and incentives to employees and facilitate the long-term growth of the company.
Cost and benefit
From the perspective of costs to the company, offering ESOPs at a time when the share price is low means relatively low cost. Take share options as an example. Current share price is the key factor affecting the value of the option and the cost to the company. The cost of ESOPs is determined and amortised on the basis of the average share price on the day of granting the option. So the offering of options at a time when the share price is low would mean a relatively low cost to be determined and amortised. Regarding restricted shares plans, the shares granted are usually shares bought on the market or new allotment. At a time of low share price, the cost of share buyback would be low, and the buyback is positive news that could enhance market confidence in the company’s shares.
From the perspective of the long-term benefits to the employees, rewards obtained at a time of low share price represent greater potential in value growth. For example, the benefits of share options to employees comes from the difference between the market price and the exercise price of the option. According to Chapter 17 of the Listing Rules of the Stock Exchange of Hong Kong, the exercise price of options must be at least the higher of:
- the closing price of the securities as stated in the Exchange’s daily quotations sheet on the date of grant, which must be a business day, or
- the average closing price of the securities as stated in the Exchange’s daily quotations sheets for the five business days immediately preceding and including the date of grant.
Therefore setting the exercise price at a time when the share price is low means a relatively low exercise price and greater potential for future gain.
Start planning early
Introducing an ESOP is no easy task. It involves the design of the plan, tax planning, setting up of a trust, reporting to the foreign exchange administration authorities, establishment of a platform for information management and exercise of options by and sale of shares to employees, as well as the final inflow of funds. The parties involved include the company itself, human resources consultants, accounting firms, law firms, trust companies and securities firms. Therefore companies should start planning and preparatory work early.
Currently, the market is volatile and the economic situation is unfavourable, but ESOPs remain indispensable. Offering ESOPs at this time means attracting and retaining staff at lower cost and offering greater room for asset appreciation to employees. Moreover, offering ESOPs is the general trend. This is an important tool to invigorate businesses and promote sustainable development.
Alix Chan, Director,
BOCI Securities Ltd
Wendy Ho FCIS FCS(PE),
Executive Director, Corporate Services,
Tricor, Hong Kong
(Provision of Professional Trustee Services)
何咏紫FCIS FCS (PE), 企業服務執行董事