Consulting » PENSIONS & EMPLOYEE BENEFITS – Signing up for a slice of the action.

Most companies now recognise the importance of having a wide selection of employee benefits, from pensions and life assurance to company cars and mobile phones. But to incentivise staff, reward them for hard work, give them a sense of ownership and increase their loyalty, companies should certainly consider employee share schemes. Many directors will have reservations, not least about the risk of giving employees ownership rights and influence over board decisions. But there’s no need to worry says Fred Hackworth of the Employee Share Ownership Centre. “It has to be made clear that the employee share scheme does not mean that the employees can, en masse, suddenly take part in major policy decisions,” he says. In part, this is because most employee share schemes don’t even involve staff actually owning shares themselves; instead they use a trust to hold and administer shares for a common fund. “Even being invited to be ESOP (employee share ownership plan) trustees doesn’t mean they’ve been catapulted to the main board,” he says. There are other pitfalls, of course. When National Freight Corporation bought itself out of the state sector, an extensive employee share ownership plan was put into place. But the benefits to both company and employees were scuppered when most of the staff sold up for a quick cash reward. Hackworth sees this as a valuable lesson in the need for clear explanations of such a scheme. “It needs consistent communication,” he stresses. Malcolm Hurlston, chairman of the Centre and prime mover behind much of the (admittedly scant) legislation covering share ownership schemes, has real enthusiasm for ‘all employee’ schemes, where every grade of worker is brought in. The proven gains of higher productivity and lower staff turnover (according to research in the US) are particularly evident when low-level and customer-facing staff are involved. “This has certainly been the case with Road Chef,” says Hurlston, “and in that case it was tea-ladies. Where people are in contact with the public, it’s very good if they have a sense of ownership.” Recent retail sector converts to all-employee schemes include Asda, Tesco, Safeway and Kingfisher. Sainsbury, which has had a scheme since the 1970s, rounds out a total of 300,000 employees in those five companies who collectively own £500m-worth of share options. One of the cheaper ways for employees to get shares is the Save As You Earn share option scheme. At the outset the employee specifies how much of his monthly salary he wants to have deducted and paid into a separate account. The savings programme must run for three, five or seven years at the end of which the company pays a tax-free bonus into the employee’s account: an account that is closed after three years gets three ‘free’ months as a bonus and a seven-year-old account gets 18 extra payments. On maturity, the whole account can be used to buy shares at up 20% below what the share price was at the beginning of the term; if the shares have fallen below that level, the account can be closed and the savings taken as cash (including the bonuses). This also helps employers, since shares only need to be made available at the time of exercise. The minimum saving is only £5 a month, an ideal employee incentive for even the lowest paid workers. A Profit Sharing Scheme also has to be open to all employees. Using a trust, the company acquires its own shares, then allots them free to employees, often on the basis of length of service, pay or seniority. The staff must leave their shares in the trust for two years to qualify, and three years to avoid paying national insurance and income tax when selling the shares. Employees can also transfer shares directly into a PEP after the qualifying period for additional tax breaks, and the employer gets tax relief on the money it provides to the trust to purchase its own shares – particularly useful if the trust is buying newly issued shares from its own parent. A similar scheme – ironically entitled BOGOF (buy one, get one free) – allows companies to give a free share for every one an employee buys. These two schemes both allow controlled incentivisation of staff in the widest way possible. They also minimise, for the staff, the effects of a falling share price in quoted companies. This must remain a concern, particularly since most of today’s schemes have grown up during a prolonged and energetic bull market, and the incentive may not appear so attractive if shares start to fall. The main problem for privately owned companies is that there is no quoted share price. The solution is to use an Employee Share Ownership Plan (ESOP) with an artificial market. A fair share price is agreed periodically between the company and its auditors, and is then submitted to the Inland Revenue’s valuations office. Once approved, employees can then trade shares with the ESOP trust at this price. To avoid unwanted volatility, companies can specify certain days in the year when trading can take place. The 1989 Finance Act is about the only legislation covering employee share plans, and allows only for statutory ESOPs of a fairly rigid nature. For example, a statutory ESOP must be open to all employees, be run by a trust where a majority of the trustees are employees and have no limits on either the amount of shares in the company it buys or where it gets its money from – it has power to borrow to buy shares. But the company gets tax breaks on the trust’s set up and running costs. Prior to 1989 – and still in many cases – tax breaks for both employees and companies comes through case law ESOPs. These normally require approval by the Inland Revenue, but can be more flexible than their statutory siblings. So far, we’ve looked at schemes which are all-employee, but the traditional public perception of share schemes is that they are for executives. There are three different forms of these. The Company Share Option Plan (before 1996, these were known as executive share option schemes) is a discretionary scheme where a company decides to award eligible employees an option at a fixed price over a set period of time. The value of the options must not exceed £30,000 if tax relief is to be applied. At exercise, capital gains tax is applicable to the beneficiary; but the company gets a tax break on the set up costs of the plan, and there are no income tax charges on the actual options themselves. Convertible Share Plans are one of the most basic ways to reward performance. A new class of share is created and sold to employees (usually senior executives) at low rates. These can then be converted to full shares with dividend and voting rights on attainment of pre-determined performance targets. For the employee, the scheme is tax efficient thanks to the low purchase price of the mock shares, and capital gains tax allowances are often sufficient to cope with the gains upon sale of the real shares. For the employer, these shares act as a huge incentive for staff to hit targets. Last, but not least, one of the more well-known schemes – and most notorious for fat-cat headlines – is the Long-Term Incentive Plan, or L-TIP. In theory, senior executives are set performance targets – increase in eps or total shareholder return, for example – which when met entitle them to an allocation of shares. Naturally, if the performance targets are too low, executives will be seen to be cashing in for no work; and if the share price appreciates too much, the total remuneration is likely to generate PR-unfriendly headlines. “It’s actually more difficult to design a long-term incentive plan (than an all-employee scheme) because it’s much more important to get the incentives appropriate to the business,” says Jacqui Lewis of remuneration specialist William M Mercer. There are also corporate governance issues, and as Lewis stresses, “you want to make sure the shareholders are going to approve it. Until very recently, some of the eps targets, in particular, were not high enough.” Some Mercer clients currently use eps growth of around RPI plus 5% as a stringent and acceptable target. But the PR effects of an all-employee scheme tend to be positive. The classic example is the John Lewis Partnership. The two things you can be certain that everyone knows about that particular retailer are that it is never knowingly undersold; and that, at the end of the financial year, every employee has a profit share bonus cheque in their back pocket and a smile on their face. Further information on employee share ownership schemes is available from the Employee Share Ownership Centre (0171) 436 9936 and ProShare (0171) 600 0984.