Financial Risk Manager

Savvy companies that aspire for the engagement not just of their shareholders but also of a wider circle of encompassing customers, employees, communities, suppliers, business partners and relevant nongovernmental organizations can be competitive in the short-term and more sustainable in the long-term as compared to those which focus exclusively on the financial bottom line. Good business is, by its very nature, socially responsible business. It is argued that if employees have an ownership stake they will be are more committed to the company. This leads to motivation and efforts, hence to productivity and profitability.

The question both for business and government is how to engender such participation and involvement and, specifically, whether this can be brought about through employee shareholding, when such individual shareholdings, taken separately, are insignificant in terms of the overall share capital of the enterprise? Even by pooling the voting rights – although not necessarily the actual ownership – of their shares, an employee shareholder trust could represent a significant voice.

However, some mechanism is needed to translate individual employee shareholding stakes into a collective voice that can deliver results, both in terms of representing the interests of employees and in convincing employees that their shareholding gives them a stake in the enterprise. Such a move could have important beneficial effects for corporate performance and hence economic growth. It could also have significant welfare effects in terms of enriching the experience of working life. Main reasons and issues need to be addressed before considering sharing ownership plans are:

The following are some of the reasons for having a sharing ownership plan:

Link between work and reward: If you are going to ask the most from your employees, they will expect something in return. Increasingly, pay is not enough. A plan that rewards employees with a share of the fruits of their labor draws a direct connection between work and reward.

Culture of ownership: When employees are rewarded based on their contributions to the company's success, they feel like owners. As owners, employees have more incentive to increase the company's profitability. However, this strategy will work only if a culture of understanding the company's challenges and contribute to the solutions has been created over time. Open twoway communication, flat management structure and employee involvement foster such a culture faster.

Following are the issues to be considered when creating a sharing ownership plan:

Empower employees to succeed: Employees must be able to make decisions that will have an impact on their bonus. "It [profit sharing] is not worth much, unless there's participation in decision making," says Bob Nelson, president of Nelson Motivation Inc. in San Diego, Calif., and author of 1001 Ways to Reward Employees.

Clear objectives: Before developing a partnership plan, any organization needs to have defined objectives in place; is it employee recruitment? Retention? Do you want liquidity for your equity? Do you want to boost production, or perhaps, you want a little of everything. The answers will help you choose the right plan for your company.

Know your industry: Old economy businesses may have actual profits to share. New economy enterprises may be years from that, so stock options carry more appeal. If your workforce is young and well educated, immediate stock awards provide more motivation. Older workers may be more interested in plans geared toward retirement.

Stage of business development: At the startup stage, a company may want to protect cash and offer stock options. At a rapid-growth or mature stage, when a company has become profitable, stock-option awards, cash and stock bonuses, or profit sharing become possible.

Employee participation within the workplace is generally regarded as important in generating and sustaining loyalty and commitment to the organization. Establishing and sharing a company ethos and culture is seen as a desirable outcome for organizational success. One reason for this is that attempting to secure effort from employees via supervision is at best costly and often difficult if not impossible. Incentive schemes may be impracticable where results depend on team effort. To work, incentives in this case need to go beyond simply appealing to individual calculations of the costs and benefits to the employee of deploying greater effort – since such a calculation would often result in the employee deciding rationally to “free ride” and still benefiting from the collective incentive scheme. Instead, such schemes need to be designed to engender collective trust and commitment.

Shared ownership by employees has long been the subject of corporate and public policy discussions. Given the advantages, meaningful employee participation through the particular route of ownership stakes has taken a number of forms over time and in different economies. Is participation actually enhanced by ownership? Do employee participation and employee share ownership have the same results? To be successful over the long term, companies need to innovate both in what they produce or offer and in the way in which they produce or the processes they adopt. The active participation of the workforce is seen as increasingly important in these processes, particularly in high value added sectors and in the “new economy.” On the other hand, the short-term interests of shareholders may get dividend rather than research and development and other innovative investments; the payback from which may not only be uncertain but also, at best, long term.

Cost cutting strategies and work intensification can bolster profitability in the short term, in the longer term developing participatory and representative mechanisms may prove increasingly important. While it is widely recognized that “flexible” employees are important for firms’ competitiveness, the above work found that such practices need to be complemented with adequate involvement mechanisms including reward systems and training, without which they could result simply in an increased intensification of work.

EMPLOYEE SHARE OWNERSHIP

From individual point of view, it makes more sense to hold shares in a company other than the one for which you work, otherwise, should that company go bankrupt, the individual risks losing his or her savings as well as their job. To advocate the holding of shares in the company for which the individuals actually work therefore requires two things. First, there needs to be a good reason for advocating such a decision. That is, one must be convinced that mechanisms exist to ensure that the sort of potential benefits associated with such ownership.

There must be a visible outcome in terms of company performance that follows as a result of such shareholdings. Otherwise, the employees would be better off holding shares in other different companies. Second, if the mechanisms are in place to ensure that there is a potential benefit then employees should be encouraged to take and hold on such ownership stakes, rather than taking stakes in enterprises other than the one for which they work.

POLICY IMPLICATIONS

Employee shareholder trusts could be used to solve the problem of the owners of listed companies (shareholders) who normally have no interest in the long-term success or otherwise of the firm. As far as the company is concerned, institutional shareholders come and go. An employee shareholder trust would be there for the long haul. They really would have an interest in the good governance and long-term success of the firm. The policy implications of the above discussion are twofold.

First, the tax incentives for employee shareholders could be further developed with the specific aim of encouraging employee shareholders to actively participate in trusts that provide a collective voice within the organization. Such a voice could have a positive impact on the performance of companies and thereby the economy as a whole. Without a belief that such individual collective shareholdings are contributing in a meaningful way towards a collective voice, there may not be the necessary commitment from the individual employee shareholders to hold on to those shares.

Indeed, they might in this case be better advised to sell and re-invest in some different sectors of the economy. There could be ways in which the specifics of how the tax incentives currently operate might be improved. More importantly, the reference to “approved” collective shareholdings is important. The current criteria for approving trusts could be extended so that schemes would be designed and operated in a manner that was clearly open and democratic, and whose objectives were to operate in the best interests of the company, rather than just to maximize financial returns to the individual shareholder.

Second, such schemes are only likely to develop and operate successfully if a body is established to ensure that this happens, along the lines of the existing supporter’s direct unit. The remit of such an organization would go beyond what is currently offered by the Treasury and Inland Revenue. It would allow the appropriate legal and other structures to be developed and to be then provided to any such collective employee-shareholding group. But it would also actively seek to enable each group to benefit from the experience of others in using such holdings to provide an effective collective voice at work.

EMPLOYEE SHARE SCHEME IN PAKISTAN

Section 14 Of Income Tax Ordinance, 2001 has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts. In this section “Employee Share Scheme” means any agreement or arrangement under which a company may issue shares in the company to:

(a) An employee of the company or an employee of an associated company; or

(b) The trustee of a trust and under the trust deed the trustee may transfer the shares to an employee of the company or an employee of an associated company.

Provision of this section would apply in Employee Share Scheme as follows:

The grant is not a taxable event: The value of a right or option to acquire shares under an employee share scheme granted to an employee shall not be chargeable to tax. However, consideration received against disposal of right or option would be taxable under the head “Salary” in the year in which disposal will take place.

Taxation begins at the time of exercise: Where, in a tax year, an employee is issued with shares under an employee share scheme including as a result of the exercise of an option or right to acquire the shares, the amount chargeable to tax to the employee under the head “Salary” for that year shall include the fair market value of the shares determined at the date of issue, as reduced by any consideration given by the employee for the shares including any amount given as consideration for the grant of a right or option to acquire the shares.

For example, if an employee is granted 100 shares of Stock A at an exercise price of Rs.25, the market value of the stock at the time of exercise is Rs.50. The amount included in the salary income on the contract is Rs.2,500 (Rs.50 – Rs.25 x 100).

The sale of the security triggers another taxable event: If the employee decides to sell the shares

immediately (or less than a year from exercise), the transaction will be reported as a Capital gain (or loss) and will be subject to tax at ordinary income tax rates and vary from different holding patterns. If the employee decides to sell the shares a year after the exercise, the sale will also be reported as a capital gain (or loss) and the tax will be reduced to a maximum level or would be exempt from tax subject to certain conditions.

CONCLUSION

The philosophy to partnering employees in the business is that if the employees feel that they have a stake in the enterprise or organization in which they work, they will be more committed to work. This in turn will bring positive outcomes in terms of productivity and organizational performance. This is time-tested theory and is based upon simple logic which

every sane manager acknowledges. Partnering employees creates significant links between progressive human resource practices that promote participation and involvement, corporate performance and organizational outcomes on the one hand and getting taxation benefit of holding such participation by the employees on the other.

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About the authors:

Athar Hussain is a senior finance professional in Iran, a fellow member of the Institute, on the visiting faculty of various institutions - professional bodies and universities, lecturing in various management disciplines.

Mubeshir Ali Kazmi, M.Com, ACA is a CFO and Company Secretary in Pakistan and on the teaching faculty of a number of institutions.

The readers are welcome to contact the authors to discuss any part of this article on email:

Athar Hussain: atharhzaidi@hotmail.com,

Mubeshir Ali: mobiali@gmail.com