Future Strategy 2006: Employee share schemes

The merits of employee share plans are being called into question due to market performance and new accounting rules, says Sonia Speedy

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Stories of secretaries walking away with £30,000 from their employee sharesave schemes were standard in the 1990s bull market.

But more recently employee share schemes have come in for a rougher ride on the back of share market turbulence and changes to accounting standards. These changes have prompted employers to question whether such schemes are the incentive they once were.

However, Nicholas Stretch, incentives partner at international law firm Norton Rose, firmly believes employee share schemes still offer the incentives they always have. "There is no way that share plans are going to fall away, either on an all-employee basis, or on an executive basis. They’re here to stay and people are accommodating all the criticisms that are being made and dealing with the pressures that are being put on them," he says.

Such pressures include the introduction of the International Financial Reporting Standard 2 and its effects on share-based payments. Prior to the introduction of this standard, UK companies didn’t have to account for employee share options. They now do, and the new requirement means companies have to value all share-based awards at the date of grant, including the cost as an expense in the profit and loss account.

Fiona Downes, head of employee share ownership at ifsProShare, believes that employ ee share plans still act as an incentive, despite the "tangible hit to the profit and loss account". But she warns: "It is important for employers to ensure that their employees fully appreciate the value of the awards on offer."

PricewaterhouseCoopers human resource services reward practice partner Tom Gosling says the new accounting rules are making companies take a closer look at whether they think their schemes are indeed delivering value. "In the past, for example, offering a sharesave scheme to employees was viewed as a bit of a no-brainer for employers. There were no accounting costs associated with it and it gave very attractive tax advantages to the employee. Now of course you have to incur an accounting cost for it, so some companies are looking at sharesave plans again and saying ‘well OK, now we recognise there is a cost to these, are we getting value from them?’"

Along with shares having become less attractive in recent years, the value of some tax benefits have also been eroded over time.

William Cohen, executive compensation partner at Deloitte & Touche, comments: "They don’t have the tax breaks that they once had. But I think that there is very little evidence to suggest that there has been a smaller use of share plans because there are less tax breaks."

Gosling points out that schemes such as sharesave and Share Incentive Plans (Sips) are still as tax effective as they have been in previous years. But he adds: "If you look at company share option plans, they don’t provide quite the same level of tax efficiency that they used to in that the limit in what you can hold at any one time is now fixed at £30,000 and that’s becoming a relatively smaller amount over time."

But, as Stretch suggests, employers are adapting their approach to share schemes. "One thing we see, particularly at the executive level, is the growing shift towards shares rather than options. That may increase," he explains.

Gosling agrees saying that increasingly in the UK, employees below the most senior levels of executive are often being taken out of option plans altogether and given other sorts of share-based incentives such as free gifts of shares, or enhanced annual bonuses which are paid in shares.

This is due to the fact that share options are more likely to be underwater and investors are also demanding tougher performance targets. Deloitte research shows a move to greater performance-based executive reward and a trend towards performance share plans being used in place of share option schemes. Thrown into the mix is the changing pension environment with A-day changes coming into effect next April.

Linklaters’ head of global employee incentives Janet Cooper suggests this will spark reviews in the way companies remunerate executives. She believes some companies may consider that share incentives will give them more value for money than pension provision.

"If they switch some of the cost of the pension into incentives and perhaps share incentives, they might get more real value now in restructuring their total remuneration towards incentives rather than pensions," she suggests.

Gosling, who also sees advantages for employee share schemes post A-day, says: "A lot of companies are looking at making it easy for people to transfer the proceeds from their share schemes into their pension funds after A-day." He adds that the flexibility A-day affords in terms of the increased contribution limit will promote change.

"With this sort of complete flexibility, I think we will see a move towards share schemes being viewed as one of a number of ways in which individuals can save for their retirement," says Gosling.

Given these changes, many firms may turn to communicating their share schemes to staff at the same time as delivering parcels of information on pensions.