Employee Stock Ownership Plan; Pros and Cons Of ESOP


If you have ever read how to motivate your employees, one of the first options that come up is ESOP. Letting your employees enjoy the benefits of stock ownership increases their loyalty towards the work. We have realized the benefits of Employee stock ownership plan over the years. Companies that make use of Employee stock ownership plans have set an example in the market.

employee stock option plan example
Employee stock option plan

Not just the loyalty but Employee Stock Option Plan also helps in tax, enjoying the tax benefits. However, it has its own drawbacks which might not be visible at first glance.

What is an (ESOP) Employee stock ownership plan?

A stock option or ownership plan is a kind of benefit that employees get in form of ownership to the companies ownership. This gives an employee the right to buy the stock of their own employer and enjoy the profit. This acts as an encouragement to the employees to increase their productivity at work.

In a closely held employees also use it as succession planning. Since these plans are mostly made available to employees at an executive position. The main objective of ESOP is to make the employees more interested in seeing the company perform well.

employee stock option plan example
Employee stock option plan example

The companies set a limit on how much ownership an employee can hold. Normally, companies limited the number of shares or percentage of capital in such cases.

Employee stock ownership plan example:

There are various ways in which stock ownership is held by employees. The most commonly seen are:

Direct purchase plan:

This is one of the stock option plans where the employee can invest their own money in the shares of the company. The best thing about this plan is that employees can enjoy tax benefits in some cases. For instance, in the USA, employees can save their salary for up to 12 months and use it to buy shares with a tax-exempt.

Stock purchase:

This is another way a company can let their employees buy the shares to a certain limitation. The rules are different from company to company.

Restricted Stock:

A restricted stock option is when a company allows the employee to own the shares but only after fulfilling certain restrictions. An example of a restriction could be the number of years worked in a company.

Phantom Stock:

As the name suggests, phantom stock is an illusionary share. With this share, an employee can enjoy a cash prize at the end of the agreement. This employee stock ownership plan benefits the employee in cash rather than in stock.

employee stock option plan example
ESOP examples

The cash prize will be equivalent to the profit of an employee that he/she would have earned if incase the company share price was doing well. Similarly, if the company is in loss the cash price would be lesser.

Stock appreciation rights:

This is another employee benefit plan which is received in cash form if there is any appreciation in the stock price.

Employee stock ownership plan benefits:

The examples of benefits associated with employee stock ownership plans are as follow:

  1. In some cases, there is a considerable amount of benefit in terms of cash for employees as well as employers when buying stocks in a company.
  2. Increase in the productivity of the employee due to their loyalty to the company.
  3. The best way to motivate the employee to work.
Benefits of employee stock option plan
  1. Works well with succession planning programs.
  2. Long term benefits in terms of cash when the company is making a profit.
  3. Decreases employee turn over rate in the company.
  4. Alternative to cash bonuses to companies when they are lacking cash.

Problems with employee-owned companies (ESOP):

An employee stock ownership option is great and has considerable benefits. There is no denying of the merits. However, there are certain drawbacks linked to the employee-owned company shares plans. The major issues are:

employee stock option plan problems
  1. Private companies generally have to buy back the shares of their employees when they are leaving the organization. 
  2. Additionally, the employees might choose to use their activity to increase their profit for the time being. They might take decisions to fulfill their objective but not focus on long term goals.
  3. This can make the employees more attracted towards the dividend rather than the actual profit.
  4. ESOP’s require proper planning before implementing them. An example of the cost associated with employee stock ownership plans is the legal cost.