Incentive Compensation and Employee Ownership

From Chapter 2, "Beyond Bribery: Communicating Short-Term Group Incentives in Employee Ownership Companies"

Employee ownership's greatest strength--a shared interest in long-term performance--is also its greatest weakness. For younger employees and people who are not familiar with the benefits of equity ownership, the rewards can seem nonexistent. Equity ownership has drawbacks as an incentive. First, the rewards are not timely, and second, the connection to daily work is difficult to see. This is particularly true where the value of the equity is realized at retirement, such as in an employee stock ownership plan (ESOP). In ESOP companies, incentives are frequently implemented to make ownership more "real." If you reward people for current performance results, so the thinking goes, they will be more aware of how the business is doing and pay attention to performance.

Among the strongest advocates of short-term incentives are companies that describe themselves as "open-book" firms. These companies point to their bonus programs as linchpins of their successful approach. Open-book advocate Jack Stack, president of Springfield ReManufacturing Corporation, summed it up this way: "What a bonus program does is communicate goals in the most effective way possible-by putting a bounty on them."

From Chapter 4, "A Primer on Sharing Equity with Employees"

Millions of employees become owners in their companies through employee stock purchase plans (ESPPs). Many if not most of these plans are organized under Section 423 of the Internal Revenue Code and thus are often called "Section 423" plans. Other ESPPs are "nonqualified" plans, meaning they do not have to meet the special rules of Section 423 and do not get any of the special tax treatment.

Under Section 423, companies must allow all employees to participate, but they can exclude those with less than two years' tenure, part-time employees, and highly compensated employees. All employees must have the same rights and privileges under the plan, although companies can allow purchase limits to vary with relative compensation (most do not do this, however). Plans can limit how much employees can buy, and the law limits it to $25,000 per year.

Section 423 plans operate by allowing employees to have deductions taken out of their pay on an after-tax basis. These deductions accumulate over an "offering period." At a specified time or times employees can choose to use these accumulated deductions to purchase shares or they can get the money back. Plans can offer discounts of up to 15% on the price of the stock. Most plans allow this discount to be taken based on either the price at the beginning or end of the offering period (the so-called "look-back feature"). The offering period can last up to five years if the price employees pay for their stock is based on the share price at the end of the period or 27 months if it can be determined at an earlier point.

Plan design can vary in a number of ways. For instance, a company might allow employees a 15% discount on the price at the end of the offering period, but no discount if they buy shares based on the price at the beginning of the period. Some companies offer employees interim opportunities to buy shares during the offering period. Others provide smaller discounts. Offering periods also vary in length. NCEO studies, however, show that the large majority of plans have a look-back feature and provide 15% discounts off the share price at the beginning or end of the offering period. Most of the plans have a 12-month offering period, with six months the next most common.

From Chapter 6, "Simulating Employee Ownership with a Rolling Bonus Program"

By varying the phantom stock idea somewhat, we can create a system that should function smoothly. It would work much like a stock appreciation rights plan (SAR), except that, unlike most SARs, it is specifically designed to make an annual payout, it is based on equity performance over a short period of time, and it is not tied to providing employees cash to make an actual purchase of shares. The idea is to mimic what would happen if employees were given stock options. With a stock option, an employee has the right to buy a certain number of shares at a price fixed today for some number of years into the future. When the option is exercised and the shares are sold, the employee ends up with the spread between the grant price and exercise price. If the option were granted at $10 in 1998 and exercised and sold at $18 in 2003, the employee would get $8 net for each share. In the best-designed option plans, employees get new options each year, thus giving them an ongoing interest in the company. While some old options will be exercised at various times, employees will always have new ones to give them an interest in the company's future.