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Employee Stock Option Plan: An Ideal Model for Protecting the Rights of Employees?

"Take care of your employees and they will take care of your Business"- Sir Richard Branson

In the current fast-moving world where companies are competing with each other on a day-to-day basis to get the slightest of an edge over the other in order to perform better in the market, it is important for each company to protect the interests of those people who can make it possible. In other words, where shareholders are considered to be the backbone of a company, protecting the rights of the stakeholders of a company is equally important, if not more.

To delve into a particular section of the stakeholders, employees have the capacity to have an impact on the business of a company directly, and therefore protecting their rights has been taken as one of the highest priorities by many companies these days. Employees who are essential pillars to any company; Companies Act along with the Securities Exchange Board of India (SEBI) have made certain benefit schemes over time.

One such is the Employees Stock Option Plan (ESOP) which through certain amendments during the course, is recognized under Section 2 (37) of the Companies Act, 2013[1] (hereinafter referred to as 'Act') and various regulations released under the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021[2] to simplify the understanding and make the full use out of this scheme.

Through the medium of this paper, the ESOP which is designed to protect the interests of the employees will be critically analyzed in the light of different schemes available and other benefits provided to the employees with respect to the statutes governing such employee benefit plans as the primary source for research and articles including case law and surveys to support the arguments made as the secondary source.

ESOP is a rewarding system introduced in the company law with the aim of aiding the dedicated and hardworking employees of the companies. As understood that the purpose is to safeguard the interests of the employees working in each and every company, therefore it is clear that the presence of such a plan is extremely crucial in the legal framework of the country in order to protect the interests of companies' stakeholders and making sure that no one's rights are being violated or are taken advantage of by the company.

As per the act "employees stock option means the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price"[3]. To understand it practically, after passing a special resolution and fulfilling the other required conditions stipulated under Section 62(1)(b) of the Act and in Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014[4], companies provide the option to the dedicated employees to subscribe for certain shares of the company.

But before they could subscribe, the vesting period is decided by the company, before which the employees are not eligible to apply for acquiring the shares and after the end of the vesting period, the exercise period starts during which the employees have the option to exercise their right and acquire the shares at a price lower than the market rate. In reality, this is not just beneficial for the employees but also in return to the company as well, structuring a win-win concept for both.

While it gives the benefit of owning cheaper shares than the price available for them in the market to the employees, it also helps them feel a sense of ownership in the company and that their hard work is being recognized and duly valued, which will lead to arising of sense of determination in the hope of receiving such rewards in the future as well.

But from the company's point of view, in addition to getting the financial assistance, the workers are now more motivated because of the reward they just received, and in the hope of receiving such rewards in the future as well, they will perform more efficiently for the company and hence improving the overall performance which essentially is what is desired by any company at the end of the day.

Lastly, from the government's perspective, the ESOPs are not tax exempted but instead compel the employees to pay the taxes twice. First at the time of allotment of shares to the employees and later at the time when they sell the allotted shares, depending upon short-term or long-term gain earned from the shares as per the Income Tax Act of 1961[5]. Therefore, making it a beneficial option from the perspective of the government as well.

However, this plan is further divided into 3 major parts as per the company's preference. This includes the Employee Stock Option Scheme (ESOS) which is basically provided to the employees as per the discretion of the Company (generally to the dedicated employees) and Employee Stock Purchase Plan (ESPP) is something which the company provides to employees on completion of a certain performance metrics.

Then Restricted Stock Units (RSU) are the ones which the company offers to the employees after occurrence/completion of an event/work. But there is also the option of Stock Appreciation Rights (SARs) wherein it is basically just an exchange of a company's shares in return for cash and therefore due to this reason its inclusion in the ESOPs list is generally in debate.

Furthermore, Employee Stock Option Plans are not the only plans provided for benefit of the employees under the Company Law. Sweat equity as defined under Section 2(88) of the Act[6] and governed under Section 54 of the Act [7] and Rule 8 of Companies (Share capital and debentures) Rules, 2014[8] essentially states that employees are given a choice to avail stocks of the company for their valuable consideration made towards the company in any form other than cash; and employee bonuses and polices such as insurance policy or medical insurance are some of the other non-stock benefits also available to the employees to protect their rights in the company. The gradual realization of the importance of stakeholders' interests has made it possible for the employees to get a considerable number of benefits varying from company to company.

Speaking of multiple benefits offered to protect the interests of the employees, ESOP is not a flawless option that all companies should opt for straightforward either, certain limitations have indeed been identified. First and foremost is the financial constraint that companies often have to deal with while promoting ESOPs to their employees.

Either their own capital is being used or bank loans will have to be taken by the companies to provide for these shares to the employees which are generally issued at a price lower than the market price. Further, when employees plan on selling these shares to the company, if the liquidating condition of the company is not good, can lead to an extreme shortage of cash flows for the company; this may lead to the company being in a continuous cycle of debt.

Moreover, the time and cost resources required to be invested during the procedural stage of ESOP (such as the passing of the special resolution in the board meeting, filling of form MGT-14 with the Registrar, etc) is considerably high enough for the company to actually think twice if the benefits anticipated to be earned will be worth the expense of these resources or not.

Additionally, from the perspective of people working in the company, alongside the non-inclusivity of promoters and independent directors under this plan, the stocks made available to employees under ESOPs comes with a lot of time restraints for the employees with respect to purchase as well as the sale of them. Also, in cases for ESOS, sometimes biasness may prevail when choosing suitable employees to be given such opportunity and who all to be left out under this plan.

Lastly, instead of the government promoting such schemes with tax relaxations, double taxes are imposed in most of the cases, making employees doubt the advantage of acquiring such shares. However, this is not the only benefit among the many other benefits provided to the employees that have these many drawbacks. In fact, to compare them with the ESOPs, sweat equity in itself comes with many restrictions under the company law that it makes hard for the companies to adopt.

The provision says:
"The company shall not issue sweat equity shares for more than fifteen percent of the existing paid-up equity share capital in a year or shares of the issue value of rupees five crores, whichever is higher: Provided that the issuance of sweat equity shares in the Company shall not exceed twenty five percent, of the paid up equity capital of the Company at any time."[9];

Unlike in the case of ESOPs wherein there are restrictions on the basis of the number of shares that can be issued for the employees of a company. Although such restrictions might be termed as essential because of the case of Sunanda Pushkar and Rendezvous Sports World company[10] which highlighted the potential fraud committed by issuing sweat equity before the 1-year gap from incorporation and the amount exceeded the 5-crore limit.

But this is not sufficient enough to cover up the extra formalities to be taken by the company, meaning the extra spending on resources. Moving on, the fixed 3-year lock-in period as per the Sweat Equity regulations exposes the stringent nature of the provision, unlike the ESOP which is more flexible and can be varied as per the requirement of the company at that point in time.

Additionally, while ESOP is an attempt to provide psychological ownership to the employees for their dedication to their work, sweat equity provides for consideration outside their main area, suggesting that it is not helping in motivating employees to work better in the long run. Last but not the least, other benefits including insurance and retirement policies or bonuses that are provided to the employees are a good initiatives to motivate them, but neither do they provide a sense of ownership towards the company, nor do they motivate them enough that employees make sure that the company performs better overall since personally, no stocks are at stakes for the employees.

Keeping in mind the few drawbacks discussed in the light of the Employee Stock Exchange Plan, we need to remember that no policy can be flawless, but it is important to note that if benefits received from it are of such a high extent that they are enough to compensate for the drawbacks, then that is the policy which should be preferred.

This is the reason why as per the survey conducted by Harvard Business Review[11], it was observed that companies that provided ownership rights to their employees grew noticeably faster with 5.05% growth in annual employment and 5.4% sales growth among the several other companies that were observed for the period of 5 years in the survey.

The existence of the ESOP model in today's world, even though it has been introduced in the mid of twentieth century highlights the extent of the positive impact it has on companies. One of the great examples of companies benefitting from the introduction of ESOP type model could be Weirton Steel Co. which adopted this plan to give employees the ownership rights back in 1984 when they were on the verge of closing, and since then for straight three and a half years the company had earned profits[12].

Similar results were shown by the currently very famous Indian company - Flipkart, wherein the 2018 deal of Walmart buying 77% of the shares of Flipkart for $15 billion, which included $500 million from the employees' stocks[13] resulted in making many of the Flipkart employees millionaires overnight. Moreover, not just that but recently Flipkart is also planning to buyback ESOP shares worth $125 million, meaning that the for dedicated employees of the company who were allotted ESOP benefits which they identified with the company's goals and strategies and worked with a feeling of belonging to the organization; now will be rewarded with huge amount of consideration for their loyalty towards the company.

Probably because of the rewards like these that the report conducted by NCEO[14], essentially found that employees with ESOP schemes were more financially stable in comparison to the ones who did not acquire this benefit. But at the same time coming back to stats of India, what is interesting to notice in the current situation is that 43% of IT companies in India have given ESOPs to more than 90% of their employees in comparison to the non-IT companies wherein only 17% have given this benefit[15].

This trend highlights that companies that are individual employee-centric in their functioning are interested more to protect their employees' rights and for rest of the companies wherein the resignation of a few employees won't matter much, believe more in not spending on this policy.

Secondly, ESOPs which are widely famous among start-ups in order to retain employees for a longer period of time were highly impacted in 2020 because the Union Budget of India 2020[16] only provided relaxations on taxes for just 1% of the total start-ups in the country[17].

To conclude the understandings from the above critical analysis made on the ESOP model of employee benefit provisions in the Act and SEBI regulations, it can be observed that it has clearly been a successful method for rewarding employees and in fact, in return has benefitted both the employees and as well as the Companies itself.

However, to keep the ESOPs in trend in today's dynamic world of multiple other employee benefit schemes available and discussed above, it is necessary for the government to make a few corrections. These can be broadly classified into two broad categories, that is relaxations on the tax imposition on the ESOPs issued and a more convenient model to issue ESOPs with respect to all the formalities that need to be done (such as board meetings or forms to be filled).

This in my opinion is highly essential and something which will have a huge impact on the companies protecting the rights of their employees through Employee Stock Exchange Plans.

  1. Income Tax Act, 1961
  2. Securities and Exchange Board of India (Share Based Employee Benefits and Sweat Equity) Regulations, 2021.
  3. The Companies Act, 2013.
  4. The Companies (Share Capital and Debentures) Rules, 2014.
  5. Union Budget of India, 2020

Secondary Sources:
  1. Corey Rosen & Michael Quarrey, 'How Well is Employee Ownership is Working?' (Harvard Business Review, 1987) accessed 17 September 2021.
  2. ET Now Digital, 'Over 100 Flipkart employees to become dollar millionaires after deal with Walmart" (Times Now, 2018) accessed 17 September 2021.
  3. Financial Express, 'Budget 2020: India's ESOP taxation harshest amongst all start-up hubs' (Financial Express 2020) Accessed 17 September 2021.
  4. National Center For Employee Ownership, 'Research on Employee Ownership' (NCEO) accessed 17 September 2021.
  5. Pavan Kumar Vijay, 'The Curious Case of Non-Sweat Equity' (, 16 May 2016) accessed 17 September 2021.
  6. Pooja Kumar, 'Employee Ownership in India' (UC San Diego) accessed 17 September 2021.

  1. The Companies Act 2013, s 2(37).
  2. Securities and Exchange Board of India (Share Based Employee Benefits and Sweat Equity) Regulations 2021.
  3. The Companies Act 2013, s 2(37).
  4. The Companies (Share Capital and Debentures) Rules 2014, rule 12.
  5. Income Tax Act 1961
  6. The Companies Act 2013, s 2(88).
  7. The Companies Act 2013, s 54.
  8. The Companies (Share Capital and Debentures) Rules 2014, rule 8.
  9. The Companies (Share Capital and Debentures) Rules 2014, rule 8.
  10. Pavan Kumar Vijay, 'The Curious Case of Non-Sweat Equity' (, 16 May 2016) accessed 17 September 2021.
  11. Corey Rosen & Michael Quarrey, 'How Well is Employee Ownership is Working?' (Harvard Business Review, 1987) accessed 17 September 2021.
  12. Corey Rosen & Michael Quarrey, 'How Well is Employee Ownership is Working?' (Harvard Business Review, 1987) accessed 17 September 2021.
  13. ET Now Digital, 'Over 100 Flipkart employees to become dollar millionaires after deal with Walmart' (Times Now, 2018) accessed 17 September 2021.
  14. Compared workers early in their careers, ages 28 to 34, with employee ownership to their peers without and found being in an ESOP associated with 92% higher median household net wealth, 33% higher median income from wages, and 53% longer median job tenure. National Center For Employee Ownership, 'Research on Employee Ownership' (NCEO) accessed 17 September 2021.
  15. Pooja Kumar, 'Employee Ownership in India' (UC San Diego) accessed 17 September 2021.
  16. Union Budget of India, 2020
  17. Financial Express, 'Budget 2020: India's ESOP taxation harshest amongst all start-up hubs' (Financial Express 2020) Accessed 17 September 2021.

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