Aug 9, 2015

Having recently introduced a share ownership plan for all Cytonn staff, we focus on the topic to demonstrate its importance to growing businesses in the country. At Cytonn, staff have both a grant of shares, at no cost, and a share purchase plan at a discounted rate.

Employee ownership schemes are an attractive form of giving employees an opportunity to participate in the ownership and decision making of their company. An employee share ownership plan (ESOP) is an arrangement between an employer and an employee, whereby the employee is granted rights to own a defined number of shares in the company, usually at a discounted price and upon fulfillment of pre-set conditions.

A company can implement ESOPs in a number of ways including; (i) issuing shares directly to its employees, (ii) allowing employees to buy into the shares of the company, often at a discount, and (iii) grant its employees an option to buy shares in the company at some future date. For any ESOP, there are 3 important stages that have to be followed:

• Grant - this is when the employee is given the right to acquire shares of the company, usually prospectively upon fulfilling pre-set conditions;
• Vesting - this is the unconditional right to acquire the shares accruing to the employee, who can then exercise their rights to acquire the shares. In most cases in Kenya, shares are allocated to ESOPs trusts and these are to vest to participating employees over a given period of time depending on the conditions outlined in the ESOP trust deeds;
• Exercise - this is when the employee acquires the vested shares at the share price agreed on the grant date.

Employee ownership schemes have been used as an employee compensation strategy for over 50 years in some parts of the world like the U.S. Since the turn of the millennium, Kenyan companies have also started adopting ESOPs, and more companies are now considering the potential benefits of such arrangements. Providing employees with ownership interest could motivate employees by aligning their interests with those of shareholders, boost employee morale and increase productivity.

ESOPs also increase a company's competitiveness and attractiveness to employees, thus enabling them to attract and retain top talent. Especially for professional services firms, talent is the defining factor in competitiveness, hence employers must consider innovative and long-term ways of incentivizing their employees, and ESOPs is one of such ways.

ESOPs are also favoured by small and medium size enterprises when developing an incentive compensation structure, as they do not involve a direct cash outflow, like a bonus payment would.

Some of the challenges in adopting an ESOP as a way of compensating employees include the employee demographic profile, which relates to their risk profile. Some older employees tend to be more risk averse and would generally prefer a compensation structure that is more certain, such as higher contributions to a pension plan and a cash bonus. Also, a challenge in the uptake of ESOPs arise from the fact that they may take a long time to vest, around 3 years for a number of Kenyan firms, which may limit their appeal to employees.

In Kenya, public companies can set up ESOPs subject to approval by the Capital Markets Authority, in order to be in compliance with the Capital Markets (Collective Investment) Scheme Regulations 2001. A number of private companies have also taken up the adoption of employee ownership schemes.

Research linking ESOPs with firm performance vary in terms of results. The relationship between ESOPs and a firm's performance, productivity and stock performance appears minimal, though a positive association exists. Advocates for ESOPs agree an ESOP alone cannot produce improved firm performance; instead the ESOP must be combined with employee empowerment through participatory management and significant participation in the ESOP programme in order to achieve improved firm results.

Below is a list of listed companies in Kenya that have ESOPs. Equity Bank has the highest ESOPs as a percentage of total shares and total value of the plan.

Source: Company Annual Reports

This data shows that only 14% of the 64 listed companies have an ESOP program. However, it is notable that other than Equity Bank with ESOP at 3.9% of the company shares, the rest of the corporate ESOPs as a percentage of all shares are negligible, with most at less than 1% of shares in ESOPs. This is in stark contrast to more developed markets such as the US where of the 900 large listed companies, 24% of the companies have a substantive ESOP program. We believe that the establishment of more ESOP programs by both listed and private companies should improve corporate performance and also help with attracting talent, not just from the local market but also from the global markets.

One key limit of both the emergence of ESOPs and the increase in the size of existing ESOPs is the prohibition by the Company's Act of corporations buying their own shares. When corporations issues shares to employees in an ESOP, it dilutes existing shareholders. This dilution can be cured by a company buying back, in the open market, an amount of shares equivalent to what has been issued as ESOPs, hence avoiding dilution.