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Employee Stock Option Plans (ESOPs) have become a very popular method of
providing compensation to managers and also an effective method to retain them for a longer period
of time. They have also been seen as an effective method of reducing agency problems
that typically arise in a company between the providers of capital, i.e., the shareholders, and
the people who have been entrusted with running the companies, i.e., the managers. Thus, it
is viewed that a proper compensation policy for the managers is essential to reduce the
agency costs arising out of the relationship between the shareholders and the managers, especially
in the case of large companies. The 1980s saw the development of theory of
management compensation through the work of a few devoted to the cause. These include Smith
and Watts (1982 and 1992), Murphy (1985), Baker et al. (1988), Garen (1994) and Haubrich (1994). The pertinent question is whether or not such plans are an effective way for
enhancing corporate value from the viewpoint of the stock markets or of the shareholders. This
study examines this question.
ESOPs in India
The Indian capital market is regulated by the Securities and Exchange Board of India
(SEBI), which has formulated the guidelines for issuing options by Indian companies as part of
their executive compensation package. These guidelines, which came into force on June 19,
1999, provide the manner in which employee stock options are to be issued in
India. They defined an option as "option given to the whole-time directors, officers or employees of a
company which gives such directors, officers or employees, the benefit or right to purchase or
subscribe at a future date, the securities offered by the company at a predetermined price". The
fair value means the option discount, or, if the company so chooses, the value of the option
using the Black-Scholes formula or other similar valuation method. A survey conducted by
M/s ESOP Direct, a consulting firm, finds that in most of the cases the companies
issuing ESOPs did comply with the disclosure requirement as specified in SEBI guidelines. In case
of Information Technology (IT) companies, ESOPs were issued across the board, whereas in
the case of companies from non-IT sectors, ESOPs were issued only to the top management.
It was also found that the average life of the ESOPs issued was four years, and in most
cases, ESOPs were issued at fair market value. Treatment of corporate actions on the ESOPs
issued varied from company to company. Wherever ESOPs are being issued across the
board, allotment is fairly proportionate across the board. In IT companies, ESOPs are being used
as a tool to motivate employees, whereas in the case of non-IT companies, ESOPs are
being issued in lieu of remuneration. The survey provides an insight into the usage of ESOPs in
the corporate sector in India. With this backdrop, this study analyzes the stock market
reaction to the award of ESOPs in India. This study is the first of its kind being undertaken in
India and thus contributes extensively to the virtually non-existing literature in this area. |
