What Are ESOP Shares?

What Are ESOP Shares?

ESOP (Employee Stock Ownership Plan) shares are shares a company issues to reward its staff, as a way of recognizing their contributions.

Depending on the company’s policy, managers and long-serving employees with strong track records and positive contributions may be granted shares outright, or given the right to buy them at a preferential price, usually far below the market price on the exchange, though often with a lock-up period during which the shares cannot be transferred.

The example below shows Mobile World (MWG) issuing ESOP shares to its employees in 2021.

Why Do Companies Issue ESOP Shares?

As mentioned, ESOP shares are a way for companies to reward dedicated employees. Whereas traditional cash bonuses raise costs and reduce a company’s profits and cash flow, issuing ESOP shares to reward employees has no effect on the company’s cash flow. This can help the company improve profits and cash flow so it can invest in expanding the business. What’s more, ESOPs that let employees buy shares at a preferential price also help the company raise additional capital for its operations.

From the employee’s point of view, being granted ESOP shares, or buying shares at a price far below the market price, effectively gives them an immediate profit as soon as they own the shares (which is exactly why ESOP shares come with transfer restrictions, to stop employees selling straight away).

ESOP shares also have a tax advantage over cash bonuses for employees. When employees later sell the shares for cash, they pay tax of only 0.1% of the transaction value, whereas a cash bonus can be subject to personal income tax of 5–30% (under Vietnamese tax rules).

The Downside of ESOP Shares

Many companies’ ESOP policies benefit employees but can expose shareholders to risk.

First, ownership is diluted. Issuing additional ESOP shares to employees reduces existing shareholders’ ownership percentages and their voting power, especially for small shareholders. In addition, the share price may fall in the short to medium term, because a larger number of shares lowers the company’s EPS and its valuation.

In addition, governance is another aspect many investors are uneasy about. A company’s “staff and employees” can include members of its executive team, such as the CEO, directors and managers. These people may already hold large stakes in the company, and the company is allowed to issue ESOP shares to reward them. This creates serious conflict among shareholders, as executives are granted, or buy, ESOP shares at prices far below the market, making it easy for them to increase their ownership.

Conditions for Issuing ESOP Shares

Not every company can issue ESOP shares. Vietnam’s Ministry of Finance sets the following conditions for companies issuing ESOPs:

• The ESOP selection program and issuance plan must be approved by the General Meeting of Shareholders.
• The total number of shares issued under the program in any 12 months must not exceed 5% of the company’s outstanding shares.
• The Board of Directors must publicly disclose the criteria and list of employees eligible for the program, the principles for setting the selling price and for allocating shares to each participant, and the timetable.

Happy trading !

“Stock Trading For A Living” Course

Green Chart designed this course to build a solid foundation in fundamental analysis & stock valuation (Fundamental Analysis), while showing students how to integrate it effectively into their existing trading system, especially for traders who already use technical analysis (Technical Analysis). The program includes 5 theory sessions and 6 months of hands-on trading guidance in the live market with the instructor.

See full course details here.