Employee stock options plan (ESOP): Should you opt?– 2: Finance Trading Times

Employee stock options plan (ESOP): Should you opt?– 2

This is part II of the article Employee stock options plan (ESOP): Should you opt?– I. Please read the first part before proceeding with this one

But is it so really safe to buy Employee stock option?

First thing: What appears to be ZERO loss or NO loss situation, in case the stock price remains below $24, is not necessarily a ZERO loss. Remember, when you are buying a stock option, then you are giving a 2 year long commitment to the organization to deduct the salary and keep it with the organization. What if you decide to switch the job after 1 year? There will be complex terms and conditions mentioned for this case.

Secondly, It comes as a cost. If you invest this money elsewhere, you may make better returns or save tax if you invest in tax saving instruments. Maybe your organization offers to keep your money in recurring deposit accounts, but there can be better return offering instruments. Hence there is an opportunity cost of capital with ESOP investments.

Thirdly, your take home salary will come down.

Fourth (and the most important one), you are at a real big risk by putting all the eggs in one basket. The risk of perfect correlation!
You work for a company. You get your salary from it. As long as the company does well, you will keep on getting good pay. At the same time, the stock price will also either remain stable or grow. You will GAIN on both fronts.
However, if things start to go bad, then everything will start going down simultaneously. Your salary will not rise or might even go down. The stock prices will also start tumbling down. You will LOOSE on both fronts.

While signing up for ESOPs, employees usually look only at the goody-goody picture. The management also tells them all great phrases – “As an ESOP holder, you will be a partner in company”, “Your rewards will be linked to your performance”, “You are an excellent performer, and hence your performance will enhance company’s results and productivity, driving the stock prices. You will benefit from it by holding ESOP”.
However, what we tend to ignore is the risk part.

Take the example of US based automobile companies. Employees of companies like GM were fired from jobs mercilessly. The same employees were also holding stock options of their employer companies. Due to job cuts, markets took it as a negative signal and the stock prices went down significantly. The employees first faced with salary cuts, later not only lost their jobs but also lost on their ESOPs. Though it is claimed that the money in ESOP is safe, it comes at a cost. Investing in ESOP means cutting your present take home salary for PROBABLE future gains – which may or may not come.

Take the case of Indian IT companies. Companies like Infosys initially trading at 2100+ range are now down to 1550 – a clear case of 25% reduction in stock price. Employees are now being hit hard with the appreciating Rupee Dollar forex rate. They are now expected to work for more hours, cannot expect any major hike in salary and at the same time their stock options may now be worthless.

Usually I don’t give a clear cut verdict on any investment instrument. But for ESOP, my verdict is a CLEAR NO. Never opt for ESOPs. Instead, invest in other sector instruments which are different from your field of job. If working for automobile, invest in IT or Utilities, if working for IT, invest in automobile, Utilities or other sectors.

ESOP is usually long dated investment requiring commitment. One may also think of going for tax-saving instruments or ETF or Index funds in the long run. But ESOP – a clear NO NO.
Table of Contents
Have Comments or Questions? Please post them as comments using "Post our Comments" link below. Your queries will be responded for free in 24 hrs!

7 Comments: Post your Comments

Ronnie said...(on 7 December 2007 at 01:57 )  

Hello Shobhit,

Thank you very much for all your good articles that you take time and effort to give the reader clear understanding on these topics. I was just going through some of the interesting articles on Equitymaster website by Ajit Dayal. They are called "Honest Truth" Here is a linke:http://www.equitymaster.com/ht/

Ronnie

Baapu said...(on 7 December 2007 at 02:52 )  
This comment has been removed by the author.
Andy K said...(on 7 December 2007 at 02:53 )  

Hi Shobhit,
I got ESOPS @83 per share when my IT company brought an IPO @465. i have got total 2200 shares, 300 per year. i have got 300 this year and will get 300 in mar 08 in my account. CMP of my company stock is around 1200 (touched 2k once upon a time). Since i get these ESOPS at very low cost i am planning to sell first lot of 300 and put all amount in the market, which comes around 360k at current price. even if i put second lot also (considering FBT as well), i would be left with 1600 more in future. I strongly feel that ESOP money is "extra" money as i have got the salaries and proper increments over the years and bonuses for my good performances. so putting ESOP money in market would not harm my financial health or my Savings done for years. What is your say on this approach rather than saying NO to ESOPS?

Thanks
AndyK

Andy K said...(on 7 December 2007 at 03:02 )  

Hi Shobhit,
After reading your views on Index funds, i have started investing in Franklin India Nifty Div. Plan since last 3 months. Nifty has given roughly around 37% and this fund has given 29-31% approx. Do you think the returns are in sink with Index? or more vigilant i have to be for tapping the market lows for putting money?

Thanks
Andy K

nickp2 said...(on 7 December 2007 at 04:56 )  

Hi Shobit,

Thanks for this educative article on ESOP.As mentioned by you that the dollar is going down.Can you please explain how and why has the dollar collapse and where is it headed say in the next year or so... Also we would like to know what is hedging of dollar and how does it affect the revenue of an organization.?
Once again thanks.

Anonymous said...(on 9 December 2007 at 21:36 )  

This is interesting...

Who is BAAPU and who is ANDYK???

What is the difference between the two???

How can 2 different people post exactly the same quetion and later delete one one them?

Andy K said...(on 11 December 2007 at 02:30 )  

Both are same... but is identity important that knowledge we share on this forum?

Regards
AndyK

Wish you all happy and fruitful trading and investing activities with safety! = = = Post a Comment

Copyright Information:
© Finance-Trading-Times.com
Please see Our Copy Right Policy. All the articles, posts and other materials on this website/blog are copyrighted to the author of this site. The content should NOT to be reproduced on any other website or through other medium, without the author's permission. Contact: contactus(AT)finance-trading-times.com

DISCLAIMER: Before using this site, you agree to the Disclaimer. For Any questions or comments, please mail contactus(AT)finance-trading-times.com.

About UsAdvertise with UsCopyRight Policy & Fair Use GuidePrivacy PolicyDisclaimer