Sharing the pain

Stock market falls and proposals from the body overseeing global financial reporting threaten to halt the increase in all-employee share ownership schemes. Paul Suff investigates.


Key points

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    • The decline in the FTSE 100 since its peak at the end of 1999 has impacted employee share schemes in several ways: the monetary value of schemes has diminished, there is the possibility of a demotivating effect on staff and employees may seek to recover their losses through demands for higher salaries.

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    • Inland Revenue figures reveal that the 101 new SAYE plans approved in 2000/01 was the lowest since 1992/93, when just 95 schemes were sanctioned.

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    • Proposals from the International Accounting Standards Board (IASB) seek to require companies to charge employee share schemes as an expense in their balance sheets.

    Employee share plans have grown in popularity among both employers and employees since save-as-you-earn (SAYE) schemes were first introduced in the early-1980s. Their standing is now under threat from a double whammy. The bear market that has engulfed the world's equity exchanges is making share schemes less attractive to staff. At the same time, proposals from the International Accounting Standards Board (IASB) requiring firms to recognise share-based payments as an expense may make employers think twice about offering such arrangements in the future.

    The figures detailing the stock market downturn are startling. From its peak at the end of 1999, when the FTSE 100 index reached almost 7,000, to the close of 2002, the value of the UK's premier companies fell 43%. In 2002 alone, the FTSE All-Share market fell 27%, which is the largest annual fall since 1974. And for the first time in 40 years, the FTSE 100 has fallen for three consecutive years.

    Pay pressure?

    Falling share prices can demotivate employees as their expectations of receiving an equity-related windfall disappear. Food retailer Somerfield acknowledged in an IRS survey of share schemes that a share price currently "underwater" - that is, at less than the price of employees' options - can have a negative impact on workers' performance and prevent companies from realising its objectives for such arrangements, notably improved recruitment and retention (See Assessing the value of share ownership ).

    The impact of collapsing equity values can be particularly demoralising for employee shareholders because they have little control over events. Overall market movements rather than individual company performance can often dictate valuations. A company may have had an exceptionally good year on all measures of corporate performance, but its share price may not mirror this if overall share values are falling. Employees may then feel that their efforts have been largely wasted. Even when company performance is the main reason for its falling share price, employees often feel that the responsibility lies with managers who have made poor decisions, rather than with their own labours. Under such circumstances, any positive effect on employee performance from either owning, or having the option over, shares is likely to evaporate. Ultimately, if share prices remain low for a long period, staff may push for higher salaries as a form of compensation.

    Should the body overseeing global financial reporting succeed in requiring employee share options to be charged as an expense in company accounts, the likelihood is that employers will opt to close or defer staff share schemes. A survey of nearly 100 public companies by ProShare1 found that 42% are unlikely to continue in the same way with their all-employee share schemes if the IASB's proposals are implemented, while more than a quarter (25.7%) say they would cease granting staff options and would stop using other share plans. If this proves to be the common employer response, again there would be pressure on them from employees for alternative rewards to offset the disappearance of a key feature of many remuneration packages over the past two decades (see box 1 for details of the proposals).

    Ups and downs

    Generally introduced to align shareholder and employee interests, allow workers to share someof the benefits of corporate success, instil in the workforce greater commitment and motivation and boost recruitment and retention, share schemes can potentially be relatively lucrativefor participants.

    Tesco, for example, which claims to operate the UK's largest share ownership scheme, paid out £116 million in February 2002 to 37,000 workers when two save-as-you-earn (SAYE) schemes matured (see box 2 for scheme details). Asda workers have also enjoyed some reasonably large payouts from maturing sharesave schemes, including more than 4,900 "colleagues" in May 2002 who received equity in the retailer's US parent company Wal-Mart worth an estimated £11 million. Asda employees saving the maximum £250 a month throughout the scheme's three-year duration would have received almost £12,000 on top of their total investment and bonus (£9,687) if they had immediately sold their stake - Wal-Mart's shares in mid-May last year were trading at more than £37 per share.

    Other groups of workers have not been so fortunate. Collapsing share prices in many technology and telecommunications companies illustrate how quickly share-based "paper fortunes" can evaporate. Marconi employees received share options when its stock was trading at £12 a share and the company was worth £30 billion and in the top 10 of the UK's largest listed firms by equity value. By mid-December 2002, a refinancing deal involving a debt for equity swap with major banks and bondholders left existing shareholders in the telecoms equipment group, including many employees, with just 0.5% of the equity.

    A less dramatic, but no less significant example is Vodafone, which operates a SAYE scheme anda SIP. Once the UK's largest company, with a valuation of £159 billion in 2000, shares in the mobile phone business fell by around 40% during 2002.

    Privatised companies also tend to have a relatively high proportion of employee shareholders because staff are usually given free shares and the opportunity to purchase more at a discounted price when an organisation moves from the public to the private sector. Some of these companies provide a further salutary lesson about the potential dangers of owning shares.

    The demise of Railtrack is one high-profile example. Around 90% of Railtrack's 12,000-strong workforce owned shares in the company when it went into administration. Railtrack's first SAYE scheme matured in July 2001, but rather than sell their options the vast majority of the 500 participants decided to keep their shares2. Although a compensation package for shareholders has now been agreed, they will only receive around 255p per share, a third less than the flotation price (380p) and 86% below their peak value (£18). A motion at the 2002 annual conference of TSSA, the union representing mainly white-collar railway employees, highlighted the impact on shareholding staff: "Railtrack employees have previously been encouraged by the company to purchase shares in that company and have been given shares as acknowledgement of performance. The effect of the administration order issued by the government has been to completely devalue these shares, thus undermining the rewards for performance previously issued by the company and having the effect that many employees who have invested their own money in the company have now been seriously disadvantaged".

    Fewer employee shareholders?

    Inland Revenues figures show that the turmoil in the equity markets may be affecting the number of employee share schemes being put forward for approval. Although there are currently 1,179 active SAYE schemes, the number of new plans approved in 2000/01 was 1013. This was the lowest figure since 1992/93, when only 95 schemes were sanctioned.

    The latest IRS Employment Review pay prospects survey also suggests a downturn in the level of employer support for share-based remuneration. Although the 2002 findings show a slight increase in the proportion of companies offering employees a financial stake in the business (22.4% compared to 17.8% the previous year), the number of respondents considering introducing an employee share scheme - just 2.1% - is much lower than either the 10% recorded in 2001 or the 13.1% in 2000 (See Settlements ease, inflation rises ).

    Findings from ProShare indicate that the popularity of employee share schemes may be on the wane among workers too. It has reported "signs that the Share Incentive Plan (SIP) [the renamed all-employee share scheme] may be running out of steam". ProShare's second survey on the uptake of SIPs found that the proportion of employees buying "partnership shares" - those that employees must purchase themselves from pre-tax earnings - had fallen from 46% to 34% between October 2001 and July 20024. The body that promotes share ownership in the UK concludes that the decline "may well reflect current consumer confidence in the stock market or less money to save generally".

    Employer responses

    The warning that "share prices can both fall and rise" should remind share scheme participants of the potential dangers of investing in the stock market. However, give or take a few blips, the market has been on an upward curve since the last big downturn in the mid-1970s. Hence most of today's investors have no experience of consistently poor market performance.

    Until recently, many commentators and investors believed that any losses suffered in a downturn would be quickly clawed back as new heights are scaled, as was the case on several occasions in the 1990s, for example. But the rollercoaster that has been the global equity markets over the past three years suggests that there will be no rapid return to previous stock market levels.

    David Schwartzer, a stock market historian, believes that "the slide in the UK stock market is likely to last for the next 15 years if history is any guide"5. He predicts that "rallies" will be followed by deeper falls. History also shows that the US stock market took until 1954 to regain its pre-depression 1929 level, while it was almostfour years before UK equities recovered their cumulative loss over the two-year period between 1972 and 1974.

    Given the circumstances, it would be surprising if the appeal of all-employee share schemes did not dive. Yet companies can do much to encourage staff to retain an interest in participating in such schemes and in retaining their equity investments. In the current climate companies must intensify their efforts to ensure employees know the risks as well as the benefits of share arrangements. Communication and education are vital and employees should be wary of investing too much in the organisation that also employs them. Marconi illustrates that employee shareholders risk losing their savings as well as their jobs.

    Some of the best companies do provide staff with financial education as part of their employee share ownership strategy. United Utilities, which won the ProShare 2002 award for the best financial education programme for employees,is one such company. The multi-utility established its first SAYE scheme following privatisation in 1989, and a new scheme hasbeen offered every year since, while a SIP was introduced in June 2002.

    The company tries to provide staff with as much information on share ownership as possible, and this includes the publication of a comprehensive maturity document. It also runs seminars, involving independent financial advisers and tax experts, when schemes mature. And the United Utilities intranet has a share page, giving the current price and SAYE/SIP scheme information.

    Although the company is keen for staff to retain their shareholding in the business, it has established a multi-stock ISA for staff so they can spread their risk and invest in other equities. Rob Briers, secretariat manager, says that despite the downturn in the stock market, employee interest in the company's sharesave schemes has been maintained over the past three years, with take up at each offer around 32% of the workforce.Overall participation in the sharesave schemes is approximately 82% of employees. The next scheme matures in March 2003 and the option price is 470p. At the end of 2002, United Utilities' shares were priced at 624p, so, barring a further stock market collapse, participants should enjoy a substantial windfall.

    Media stocks have suffered more than most over the past year or so, with shares in publishers and television companies buffeted not only by the general market decline, but also from falling advertising revenue that has dragged down profits. Nonetheless, Pearson, publisher of the Financial Times, won the 2002 ProShare award for best performance in fostering employee share ownership in a large organisation. This is despite the company's share value falling almost 39% from its 2002 high by the end of the year. Around 47% of the company's 30,000 global workforce (excluding the US, which operates its own employee stock ownership arrangements) participate in Pearson's SAYE and SIP schemes.

    Pearson has invested in a range of electronic tools to enable staff access to information about employee share arrangements, including an online registration facility.This service went live in 2002 and 85% of all staff share applications in the UK were made online last year. The corporate intranet also provides employees with "real-time" share information, and each Pearson business has its own share schemes co-ordinator to help staff with any equity-related problems. These co-ordinators have access to a password-protected site containing relevant data.

    Waiting for the bull to return

    SAYE schemes retain a degree of attractiveness because participating employees still receive atax-free bonus on their investment - although the rate of interest was reduced in August 2002 - irrespective of equity performance. But many investors will be disappointed that the returns are not higher, especially as the information accompanying invitations to participate in a plan tend to highlight the potential gains through illustrative examples. The premise is that at the end of the contract the company's share price will have risen and employees who have invested will receive a profit.

    The "free" shares allocated to staff under a SIP will continue to be a welcome bonus to those employees who receive them - though only 37% of plans offer this in some form according to New Bridge Street Consultants6. Nonetheless, recipients are unlikely to attach much value to such allocations and will increasingly come to disregard them as a significant part of the overall reward package. Certainly, employees will be less than enthusiastic about investing their own money in schemes - such as "partnership" shares- that constitute a greater risk than SAYE, as long as the present uncertainty in global stock markets continues. As a result, the government, at least in the short term, seems unlikely to attain its target of around 3,500 companies operating a SIP.

    In the longer term, it is hoped that SIP schemes will play a central role in the promotion of more socially inclusive wealth creation. The Confederation of British Industry (CBI) and the Employee Share Ownership Centre, an independent organisation dedicated to furthering the interests of employee shareholders, are two of the key backers of such schemes. At a forthcoming conference in March, they will stress the significant tax benefits to be enjoyed through participation in SIPs, by both employers and employees. In addition, the CBI's director general, Digby Jones, will argue that despite the current weakness of the stock market, "a good share plan, implemented properly, can be invaluable in motivating employees and giving them a stake in the success of the business."

    Ultimately, the future of all-employee share schemes will depend on how quickly the market rebounds. Many employers and employees will be hoping that the market recovers and does not fall for a fourth year before any options they hold become exercisable. One bright note among the gloom: the UK stock market has only twice in the past 100 years fallen for four consecutive years.

    Written by Paul Suff, a freelance journalist specialising in employment issues (paulsuff@onetel.net.uk ).

    1. "Option accounting threatens employee share schemes", ProShare press release, 1.11.02.

    2. www.mhcc.co.uk/esop/esop/esopnews.asp .

    3. www.inlandevenue.gov.uk .

    4. Share incentive plan survey autumn 2002: an examination of the impact of the share incentive plan over the past 12 months, ProShare, available free from www.proshare.org .

    5. www.schwartztrends.com .

    6. Executive briefing, New Bridge Street Consultants, May 2002.


    Box 1: Accountancy changes?

    The International Accounting Standards Board (IASB) has stated that all UK companies should make the cost of employee share options an expense on their balance sheets. The body that regulates financial reporting issued ED2 "Share-based payment" on 7 November 2002.Its proposals, which are due to be finalised by the end of 2003, will come into effect for both listed and unlisted companies for accounting periods beginning on or after 1 January 2004. Even if this date is missed, European Union proposals to establish common accounting standards across all its member states, which are broadly similar to what is proposed by the IASB, should come into force by 1 January 2005.

    Organisations such as ProShare, which works to promote share ownership in the UK, have reacted angrily to the IASB's proposals. Chief executive Diane Hay said the proposed standard would "threaten to put in reverse 20 years of progress in employee share ownership". There is also concern that the impact of ED2 on share schemes will be similar to that following the introduction of FRS17 on pensions, which is cited as one of the major reasons that firms have abandoned their final salary schemes.

    The IASB view, which was first aired by the international body's UK arm in 2000, is that share options are part of employee compensation and their cost should be based on a fair valuation of shares or options at vesting date - that is, the date at which employees become entitled to options or shares. At present, the cost of share options falls on other shareholders, in the form of dilution, and specifically earnings per share.

    Should the IASB succeed in establishing ED2, the impact on corporate profits is potentially high. One study estimated in 2001 that prior to its merger with the Halifax, the Bank of Scotland could expect to charge £40 million or 7% of profits each year to cover the cost of its share options.

    Nonetheless, some companies are already beginning to treat employee share options as a cost. HSBC is one such company and in the first half of 2002 the financial services group said options to 70,000 employees cost it $127 million. In the US, where a similar, but voluntary, standard (FAS123) is in operation, more than 100 large corporations have started to expense employee share options, including Coca Cola, BankOne and the Washington Post. Although the initial reaction was that the accounting change would negatively affect the stock market valuations of these companies, this has not proved to be the case. A study by Towers Perrin found that the share price performance of these companies was the same, on average, as the S&P5001.

    1 www.towers.com/towers/enews/monitor/Dec_02/Dec_02_article3.htm .


    Box 2: All-employee share incentives: main schemes

    Share incentive plan (SIP) previously known as all-employee share option plan (AESOP)

    Under a SIP employees can purchase shares - described as "partnership shares" - from pre-income tax and pre-National Insurance salary up to the value of £125 each month (companies can establish a minimum of not more than £10 a month). Employees can receive awards of shares through one of two ways, or a combination of both:

  • free shares up to a maximum value of £3,000 per tax year (allocation may be performance-related, although special rules apply); and

  • employer matches the number of partnership shares with further free shares (maximum award is two matching shares for each partnership share).

    Free shares are purchased by a company-funded "trust" and held for at least three years to receive the full tax benefit. Dividends paid on shares while they are in the scheme will be tax free if they are used to purchase additional equity (the maximum amount that can be reinvested is £1,500). These "dividend" shares are also held in trust for at least three years after which time they can be sold.

    Company share option plan (CSOP)

    A company scheme under which employees are given the right - an option - to purchase, now or in the future, a set number of shares in the business at the current price. There is a £30,000 ceiling on the number of shares an individual can hold at any one time. CSOPs attract certain tax advantages. A single scheme may be established to cover a group of companies where one company is the controlling business.

    Enterprise management incentive (EMI)

    Enterprise management incentives are designed for smaller, relatively new, companies to help them recruit and retain high calibre staff. Independent companies with gross assets not exceeding £30 million can award EMI options over shares to any number of staff worth upto £100,000. The overall value of options that can be awarded is£3 million.

    Save-as-you-earn (SAYE) share option plan

    Scheme under which employees are given the right - called an option - to purchase, at a specified future date, shares from monies saved under a save-as-you-earn contract. Staff save a fixed monthly amount, between £5 and £250, for a specified period - three or five years (savings may be left in the account for an additional two years) - and they may purchase shares in the company when the savings contract ends or opt to take the proceeds, including a tax-free bonus or interest payment, in cash.

    A special savings contract with a building society or bank, in which participants invest a fixed amount each month over a set period, begins when the share option is granted. Employers may offer participants the choice of a savings contract over three years (36 monthly contributions), five years (60 monthly contributions) or seven years(60 contributions, which are left in the account to mature for a further two years). Individuals can participate in more than one scheme but the total monthly amount saved under all schemes must not exceed the maximum savings amount. The SAYE contract attracts a bonus based on the length of contract - a three-year contract currently pays a bonus equal to 1.8 monthly contributions; a five-year contract pays a bonus equal to 5.7 monthly contributions; and a seven-year contract pays a bonus equal to 11 monthly contributions (rates were revised in August 2002).