Employee Share Option Plans (ESOP’s)

Employer Share Option Plans (“ESOPs”) are an excellent way to incentivise staff members.

The Accounting and Valuation considerations, however, can be a nightmare. With our vast experience, we can make the process much easier for you.

Share options have so many uses – we see them in M&A transactions, hedging strategies and, of course, the incentivisation of employees.

Employee share option plans (“ESOPs”) are created for the benefit of employees but also to make sure that the behaviour (of these employees) is aligned to the long-term goals of the employer. As soon as one or more suspensive conditions are fulfilled, the employees may then receive either shares or some cash payment related to the growth in share price. In short, employees are rewarded, or paid, with shares.

The accounting for this arrangement is somewhat tricky, especially as it is almost impossible to predict the future behaviour of a share price. Fortunately, “IFRS 2: Share-Based Payment” provides fairly prescriptive guidance around how employers should account for this expense as well as the shares or cash payment they have promised their employees.

The valuation considerations, however, are way more challenging. We first need to take a step back and understand that the employer has not granted its employees actual shares, but rather the option to receive shares (or some cash payment linked to this). This then leads to the next set of very important questions:

  1. What is the current price of the share (over which the option exists)?
  2. What strike price will the employee need to pay when he / she decides to exercise their option (i.e. at exercise date)?
  3. How much time remains until this exercise date? (This is the term of the option).
  4. How volatile is the share price, or is expected to move about over the term of the option?
  5. What dividends will be paid during the remaining term of the option?
  6. What is the expected risk-free interest rate during this time?

Once we have answered these questions as accurately as possible, we then need to choose the correct valuation model. We may be able to use relatively simplistic valuation techniques such as Black-Scholes-Merton (“BSM”) models or American Binomial Models. If the answers to some of the questions above are not clear cut, however, we then have to resort to more complex methods such as Geometric Brownian Motion (“GBM”) with Monte Carlo simulations.

The hardest part about Employee Share Options is navigating the maze of questions, and knowing which path to follow.

Please Contact us for more information on how we can assist you with any Employee Share Option queries that you may have.