An employee stock ownership plan (ESOP) is a qualified defined-contribution employee benefit (ERISA) plan designed to invest primarily in the stock of the sponsoring employer. ESOPs are "qualified" in the sense that the ESOP's sponsoring company, the selling shareholder and participants receive various tax benefits. ESOPs are often used as a corporate finance strategy and are also used to align the interests of a company's employees with those of the company's shareholders.
BREAKING DOWN 'Employee Stock Ownership Plan - ESOP'
Since ESOP shares are part of employees' remuneration for work provided for the company, ESOPs can be used to keep plan participants focused on company performance and share price appreciation. By giving plan participants an interest in seeing that the company's stock performs well, these plans are believed to encourage participants to do what's best for shareholders, since the participants themselves are shareholders. Employees are provided with such ownership often with no upfront costs. The provided shares may be held in a trust for safety and growth until the employee retires or resigns from the company. Once an employee retires or resigns, the shares are given back to the company for further redistribution or are completely voided.
Employee-owned corporations are companies with majority holdings by their own employees. As such, these organizers are like cooperatives, except that the company's capital is not equally distributed. Many of these companies only provide voting rights to particular shareholders. Senior employees may also be given the benefit of getting more shares compared to new employees.
Stock ownership plans provide packages that act as additional benefits for employees in order to prevent hostility and keep a specific corporate culture that company managements want to maintain. The plans also stop company employees from taking too much company stock.
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The major benefits of awarding Employee Stock Options are mentioned below:
Lock-in Period:
ESOP’s come with a lock-in period known as vesting period and employees can exercise the options only after this period. If the employee leaves the organisation before completing the specified period – these ESOP’s get lapsed and the employee will not get any benefit.
A ‘Sense of Ownerhip’ for the employees:
When the employees are given shares of the same company in which they are working, it gives them a sense of feeling that now they are not employees of this organisation but are the owners. As they are now they owners, they also have a share in the profits of the company. In fact, since employees directly benefit from the increase in the share price, they focus on overall value creation for the company.
Kind instead of Cash
ESOP’s are a way of awarding the employees in kind instead of cash. In the initial days of ESOP’s in India, small organisations who were cash strapped used to give ESOP’s to their employees to increase the overall pay package. In this manner, they were able to compensate the employees in kind without affecting their cash reserves (if a organization issues ESOP’s- its cash reserves are not affected )
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