Well aimed share schemes hit target

Share plans can produce all manner of targeted impact, geared towards both general workers and high flyers, says Jenny Keefe

Case study: United Utilities

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The first rule of employee share schemes is: staff should only gamble what they can afford to lose. While sharesave schemes offer a relatively safe bet for low-income staff, those who can afford to take a punt on riskier plans can be quids in.

Employee share plans may come in all sorts of shapes and sizes, and involve different levels of risk, but all are aimed at boosting business by giving employees a stake in their company’s future. David Craddock, independent consultant and author of the Employee Share Schemes Handbook, says: “There are three reasons why companies introduce share schemes. The first is recruitment and retention. Employees these days will actively look to see if potential employers embrace share schemes. “The second is motivation and incentive. Which would you prefer: 100% of £100 or 75% of £200? Of course it’s often better to own less of the bigger cake than more of a smaller one. Employee share schemes feed off this.

You are essentially seeking to help the company grow by empowering and recognising employees.” Finally, and most importantly, is unity of the workforce. “You are trying to unite all the people who are involved in the company to work towards the same goal.

So if, for example, you’ve got a three-year plan you must look for schemes that will motivate people heavily over [those] three years.” The case is compelling, but now for the tricky bit: knowing which scheme to plump for. The success of share schemes, introduced in the late 1970s, is driving a small army of providers, all presenting employers with an array of different options.

There are currently four Inland Revenue-approved share plans: sharesave schemes, share incentive plans (Sips), company share option schemes (Csops) and enterprise management incentive (EMI) schemes. The best-known of all the schemes is sharesave, which dates from 1980 and is also known as Save as You Earn (SAYE). Here employees save anywhere between £5 and £250 a month.

Organisations can choose when the options are exercised, after three, five or seven years. As an all-employee scheme, it must be open to all workers with more than five years’ service. The real boon of these schemes is that at maturity staff have two options: they can buy shares at a special rate – usually 20% below the market price when the scheme started – or take their savings as cash if the market price is below the option price.

You really can’t lose, which makes the scheme perfect for the risk adverse or lower paid. “Your employees are less likely to take a risk than an entrepreneur,” says Craddock. Whisper it quietly but you may also want to take gender make up into account when choosing schemes as research shows that men and women have different attitudes to risk in relation to investing.

The Pensions Research Forum’s annual survey 2005 grouped individuals into three groups: low, medium and high, representing their tolerance for risk. Some 33% of women fell into the most risk-averse group, compared with just 13%of men. Sharesave may be a sure thing, but its pay outs are limited. Up the stakes a bit and Sips offer larger potential gains for employees slightly higher up the pay scale.

However, they are riskier because staff buy shares at market price each month meaning they can lose out if the share price falls or the firm goes bust. Limits are more generous than with shavesave. Employees buy the shares out of their gross pay and can spend up to £1,500 a year or 10% of their salary – whichever is lower. Employers can give staff up to £3,000 worth of shares each year, free from income tax and National Insurance Contributions.

They can also match employees’ savings by giving staff up to two shares free for each share they buy. Again, Sips are an all-employee scheme and must be open to all workers with 18 months’ service. The amount staff can put into a sharesave or Sip, however, is pocket money to top executives. Justin Ricks, senior manager of employee solutions at accountants Grant Thornton, says: “All-employee schemes are more interesting for the general workforce than for the more senior executives because the amounts involved are minor compared to their overall level of compensation. “When you are looking at more high level employees stock option plans tend to be more performance related, so the more senior the individual the more they can make through share schemes.

The classic stock option plan is where you award some options and the number of times or when those options can be exercised is related to performance. “And then if they leave they lose [the shares] so it also ties them in to the firm, killing two birds with one stone.” Where small- and medium-sized businesses have assets of £30m or less and want to reward senior staff, they can opt for an enterprise management incentive (EMI) scheme. Companies can grant options up to a maximum of £3m, subject to a limit of up to £100,000 per employee. The cherry on the top of the cake is that no tax or national insurance is charged when the employee exercises the options. “It’s very much aimed at small start-up businesses.

EMIs are great for unlisted companies that don’t have a lot of cash to pay but want good people,” says Ricks. At the luxury end of the market are company share option plans (Csops); a juicy incentive for top execs. The scheme was originally introduced in the early 1980s (when it was called the executive share option scheme). “The reason why the scheme was introduced at the time was to give a boost to British industry and in particular those who ran British industry,” says Craddock.

Employees are given options to buy shares at a fixed price at a fixed time and have no income tax liability when they exercise the share options. “As a consequence of the credit explosion in the late 1980s people made [such] an enormous amount of money that [the] scheme became discredited. Some journalists at the time referred to it as the fat cat scheme,” he adds.

When Kenneth Clarke reformed the plan in 1996, he changed its name and reduced the cap on the total value of shares from four-times salary to £30,000 (at option price). There is, however, stormy weather ahead for share schemes. Dr Andrew Robinson, senior lecturer in accounting and finance at Leeds University Business School, says: “A key issue concerning share options is the new accounting regulations which now require a charge to be made against profits for these schemes. This is likely to act as a strong disincentive to set up or continue such schemes.”

New rules by the International Accounting Standards Board mean the value of any share option must be deducted from profits. The new legislation is taking its toll.

New Bridge Street Consultants’ Total Reward Survey 2005 found that one in six of Britain’s 150 biggest companies has stopped offering sharesave schemes since the changes. And smaller firms are abandoning them at the same rate.

David Pett, head of share schemes at law firm Pinsent Masons, says: “It’s a widely-held view that because of the accounting terms sharesave [schemes] are expensive and that’s why they’ve fallen out of favour. But nor does it follow that people are replacing them with share incentive plans. The tendency just seems to be not to replace them at all.”

The Facts

The Chartered Institute of Personnel & Development’s Reward management survey 2006 found that 40% of private sector employers offer access to an employee share scheme. Of these firms four-out-of-ten employers provide sharesave schemes, the same number offer executive share options, 33% run Sips and 29% offer Csops. Proshare’s Sips and SAYE 2004 research found that, when granting options through sharesave, 83% of firms give a 20% discount on market price. According to the same research, the average employee saves £70 a month in sharesave. When running Sips, 87% of firms offer partnership shares and 50% offer matching shares, though just 30% offer free shares.

Case study: United Utilities

In 2002, water company United Utilities scrapped its sharesave scheme ahead of the game, replacing it with a share incentive plan (Sip)Some 20% of its 16,000 employees now take advantage of the plan, through which they get one free share for every five purchased.

Reg Unsworth, group reward manager, says the Sip has several advantages over sharesave. “The new Sip is flexible compared with sharesave. Also, unlike sharesave, employees can take advantage of dividend payments – a big factor for us as we are a high-dividend yield company.”

Staff can use dividends on the shares to reinvest in further shares. Unsworth adds that apart from the five-year tax tie-in drawback, the Sip encourages saving among all demographics. “Even lower-paid employees often save significant amounts. It’s flexible so they can decide when and how much to save.

Their return is likely to be higher than other savings arrangements.”