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ECONOMIC POLICY 29: Every worker an owner Share incentive plans for employees The problem: building human capital How can a company make the most of its human capital? What forms of incentives can be employed to incentivize staff and retain them? The idea: share incentive plans One way is to offer shares to all staff employed by the company. Governments can encourage a dynamic entrpeneurial economy by devising tax breaks for such schemes. Examples: motivating employees In the United States, share incentive plans have proved a winner for many companies. An analysis by William M Mercer concluded from a wide-ranging study of US companies that broad-based option grants had improved sales growth per employee. For the period 1993 to 1997, a comparison of 49 companies employing broad-based share option plans against 301 firms which did not do so, revealed that the former earned anything between $9,000 and $28,000 more in sales per employee than the latter. These findings are confirmed by a study undertaken by Washington University. In an analysis of the performance of 205 major companies, those firms which offered a popular employees share option plan outperformed those with less attractive employee share schemes by 22 per cent per annum. Other academic research also suggests that share-based remuneration is likely to work best when it is linked directly to other best-practice human resource programmes such as decision making at the shop floor level. In the United Kingdom, a study by Bradford University found that profit-sharing arrangements put in place by companies across a broad spectrum of manufacturing helped, in conjunction with other factors, to improve productivity by 23 per cent. Some of the UK's most important share option arrangements were part of its privatization process. At the point of privatization, employees in nearly all the UK state industries were given a stake in the new company, usually ranging between 2%-8% of the stock, split equally between the workforce, with options to buy further amounts at discount prices. Even the Labour Chancellor of the Exchequer (finance minister), Gordon Brown, recognized the merits of employee share-holdings and made changes in the tax code to allow them to spread down to the most junior employees in any business (as 'All Employee Share Option Plans' or AESOPS). Thus in the Finance Act 2001, the volume of share options that companies are able to grant was doubled to £3millon and the limit on the number of employees who can hold options was removed, allowing ordinary shop-floor workers access to such schemes for the first time. UK workers can now buy up to £1500 worth of company shares free of tax and national insurance contributions; and employers can match this by giving two shares for every one which the employee purchases. As long as they hold their shares for at least three years, employees who then sell them have to pay tax only on the original price of the shares, and not on any gains made. And there are other tax benefits on dividend payments. In the Netherlands, the number of companies adopting some kind of participation scheme is rising rapidly, with some thousands more companies aiming to bring in such plans within the next three years. Employee ownership can be a powerful tool to achieve privatization: in Portugal, privatization law permits for employee share option plans, and in Hungary, ESOPs have played a major role in effecting around 150 privatizations; Chile has adopted the same technique (see the chapter Freely Employed). Assessment: incentive is no fable In a modern economy, employee share ownership schemes can bridge the gap between employees, managers and shareholders by aligning their interests. Everyone can share in the success of the enterprise. Share incentive plans do not improve productivity all on their own. They must be linked to other participatory practices such as management supervision, internal corporate communications and decision-making. Not all companies should adopt share incentive plans for employees. Where firms have relatively little control over crucial exogenous factors such as commodity markets, regulatory authorization or political change, it may be inadvisable for employees to have a significant proportion of their savings held in the company they work for. Furthermore, if the company is forced into bankruptcy, employees would lose not only their jobs but their savings. There is also a danger that employees, including senior managers, may become overly risk averse if they think this may impact on their company's share price. Share incentive schemes that do not address the problem of risk result inevitably in higher remuneration costs, higher job turnover and excessive conservatism among employees. The evidence suggests that employee ownership is most likely to enhance productivity when share price volatility is not so sensitive to exogenous industry and market factors. It also tends to help if work is organized around teams and if internal corporate communication channels are open and relatively unconstrained. Share schemes are essentially a form of performance-related pay. Shares can be given over on the basis of success in meeting designated performance targets, for example. To succeed, however, employers must seek to allocate shares in an equitable manner. If the allocation is not seen to be objective and fair, staff morale will inevitably suffer. 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Copyright 2002: Adam Smith Institute
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