DU SOL B.Com 3rd Year Human Resource Management Notes Chapter 15 Performance Linked Compensation (Variable and Incentive Wage Plans)

DU SOL B.Com 3rd Year Human Resource Management Notes Chapter 15 Performance Linked Compensation (Variable and Incentive Wage Plans)

Question 1.
What is incentive wage payment system ? Discuss merits and demerits of incentive system of wage payment.
Define wage incentives. What are your reactions to the incentive system of wage payment ?
Definition And Objectives Of Incentive Plan:
In order to remove the defects of time wage system and piece wage system, management authorities of wage payments which blended the two systems in such a manner that the interests of both – the workers and the employees might be protected under these systems, time and speed form the basis of wage payment.

Technically, these methods are called “incentive plans”. These plans provide an incentive to workers to produce more and are paid bonus or premium for additional work. According to Hummel and Nickerson, “It refers to all the plans that provide extra pay for extra performance in addition to regular wages for a job.”

According to the National Commission on Labour – “Wage incentives are extra financial motivation. They are designed to stimulate human effort by rewarding the person, over and above the time rated remuneration, for improvements in the present or targeted results.” We may define a wage incentive as a system of payment under which the amount payable to a person is linked with his output or performance.

Objectives Of Wage Incentive Schemes:
Wage incentive schemes aim at the fulfilment of following objectives:

  1. To improve the profit of a firm through a reduction in the unit costs of labour and materials or both.
  2. To avoid or minimise additional capital investment for the expansion of production capacity.
  3. To increase a worker’s earnings without dragging the firm into a higher wage rate structure regard less of productivity.
  4. To use wage incentives as a useful tool for securing a better utilisation of manpower. Better production scheduling and performance control and a more effective personnel policy.

Merits of the Incentive System:
Incentive system of wage distribution has following merits to its credit:

  1. Incentive system is a healthy way to strengthen the productive front of the industry.
  2. Employers as well as workers, both are at advantage.
  3. Incentive system reduces the burden of heavy supervision costs.
  4. ft has been found that the cases of absenteeism are comparatively lower than in other systems of wage payment.
  5. It develops healthy industrial relations and reduces chances of disputes between the workers and the employers.
  6. Incentive system provides better scope,for developing human ingenuity.
  7. Incentive system develops the feeling of co-operation among the workers.
  8. Supervision instead of acting as watch dogs, now act as individuals responsible for managing machines and materials being employed.

Demerits of the Incentive System:

  1. Though it is expected that under incentive scheme production must go up, but there is equal chance of contrary happenings.
  2. It is very difficult to consider and achieve the psychological and social dimensions.
  3. Employment is uncertain.
  4. It is difficult to measure the proportionate value of the extra work done.

Question 2.
Why do employee oppose incentive wage payment system ?
Opposition Of Incentive Wage System:
The main purpose of incentive wage plans is to induce the workers to work more and to show better performance of their ability and capacity on work and to share the gains of such increased productivity between the workers and the management. In this way, such incentive wage plans are in the best interests of the workers. But workers do not always support such plans. Sometimes workers oppose such plans because of following reasons:

1. Inefficient workers – If workers are inefficient and they feel that they cannot attain the desired standards to get the benefit of the scheme they oppose such scheme on the pretext of its being complicated and its standards too difficult.

2. Arbitrary Standards – For introducing an incentive plan, standards for work and time are fixed by the management by job-evaluation technique which is a complicated device of evaluating the jobs. Labour always charge the management of fixing the standards too difficult to attain and always oppose such standards.

3. Opposition from Indirect Workers – Incentive wage plans are worked out for workers who are directly engaged on machines. Indirect labour who is indirectly associated with production is outside the scope of an incentive plan. It creates bitterness and animosity.

4. Change of Circumstances – Every incentive scheme is designed in a particular set of circumstances. The level of incentives offered under it may be quite inadequate in a different set of circumstances. The result is that workers have disputes and grievances with employers.

5. Other Reasons – If workers are ready to wrok to their ipest but they are prevented to work because of certain reasons beyond their control such as frequent power failures, non-availability of materials and equipments etc. Workers oppose incentive plan because they are at loss due to no fault of them.

Question 3.
What conditions are necessary for the successful implementation of wage incentive plans ?
Describe the essentials of a good incentive plan of wage payment.
Essentials Of A Good Incentive Plan
Following principle should be adhered to make the wage incentive plan successful:

1. Suitable climate – Success of an incentive plan greatly depends on the kind of relation between management and workers. If the relations are good,, any incentive plan may work successfully. If there is mutual ill-will workers may oppose it considering it as an attempt by the management to force them to work hard. It is necessary that before introducing any incentive scheme, workers and management should discuss the scheme.

2. Information as to goals – The workers should be told about the objectives and goals of the incentive plan in clear terms. The objective may be to increase the quality or quantity of the production or both. Other information like rate of and calculation of premium should also be spelt out clearly.

3. Simplicity – The incentive scheme should be easy to understand and simple to operate. It will build up confidence and trust in the programme.

4. Just and Equitable – It should take into account the skills and abilities of workers. If it is unduly biased in favour of efficient and experienced workers, it will lack motivation for those who are not so. If it seeks to favour inexperienced and inefficient workers, outstanding and ambitious workers will not have any use for it. Thus, the scheme should equally motivate all workers efficient and inefficient

5. Flexible – An incentive scheme should be flexible enough to be adapted to the needs of any change in the situation.

6. Attractive – Incentive payments, should be large enough to attract the employees. If a worker already earning Rs. 500 a month is to get an extra benefit of Rs. 25, he may not consider it worthwhile to strain himself for such a petty gain.

7. Economical – The cost of operating an incentive scheme should be compared with the benefits accruing from it. The gains and benefits should exceed the cost of its implementation.

8. Minimum guaranteed wages – The employee should be assured of a minimum base wage as determined by job evaluation method, irrespective of his output. This gives the worker a feeling of security about his means. The base rate may be reduced due to circumstances beyond his control.

9. Grievance procedure – An incentive wage plan gives rise to grievances of all sorts. Therefore, the management should have an effective grievance procedure to deal with complaint and dissatisfaction ventilated by employees.

10. Stability – The standards and rates once fixed under an incentive plan should not be frequently changed unless there is a substantial change in methods, materials or equipment used in production process. Frequent change in standards and rates will demoralise workers.

11. Comprehensive coverage – Any scheme of incentive wages should embarrass all jobs. If any job in the unit is left out, the workers so neglected will develop grievances and will shake the,faith in management.

12. Conducive to workers health and welfare – The incentive wage plan should not aim at overstraining workers because it may tempt the workers to work hard in order to earn more and management may also be benefited but such gains will not last longer. In the long run, its consequences will be disastrous because it will have ill effects on workers health.

13. Attainable standards – Standards set for performance should reasonably attainable by average employees. They should be neither too difficult nor too easy to attain by average employees. They should be neither too difficult nor too easy to attain. Moreover, standards should be scientifically fixed i.e. through careful work measurement device (time and motion studies, work sampling etc.).

Question 4.
Discuss briefly the various incentive wage plans.
Various Incentive Wage Plans:
Mainly there are two kinds of incentive wage plans:
(A) Individual Incentive Wage Plans
(B) Individual Incentive Wage Plans.
(A) Personnel Incentive Wage Plans -These plans motivate the individuals to produce more. Such plans may be based on time or production. Following are some of the individual wage incentive plans.

1. The Halsey Premium Plan -A mechanical engineer F.A. Halsey devised this plan. It is a simple combination of the time-speed basis of payment. The worker gets his wages for the time he works. For the calculation of premium, a standard time is fixed for each job on the basis of past performances. If the worker finishes the job before this standard fixed time, he gets bonus for the time saved by him.

The rate of bonus is 30% to 50% of the wage payable for the time saved. Suppose a worker gets his wages @ 60 paise per hour. He finished his work in 15 hours for standard time fixed is 20 hours. Thus he saves 5 hours. He will get a total wage of Rs. 10.50. This is worked out as below:
DU SOL B.Com 3rd Year Human Resource Management Notes Chapter 15 Performance Linked Compensation (Variable and Incentive Wage Plans) 1
He will get Rs. 10.50 and will also earn something more by utilising the time saved i.e., 5 hours.

The chief merits of this plan are:

  1. Slow workers are guaranteed a fixed time wage.
  2. Efficient workers get extra wage.
  3. It is an easy and simple device of introducing efficiency.


  1. The worker gets only 50% benefit of his efficiency. It is said that he can earn more in the saved time, but where, is the work.
  2. The quality of the work is. not cared for and the waste of material increases.
  3. There is no scientific method of fixing the rate of premium for the time saved.
  4. Standards are fixed on the basis of past performance.

2. The Rowan Premium Plan – It is widely used in England. It was introduced by James Rowan of David Rowan and Sons, GlassgOw in 1901. It is modification in the Halsey’s Plan. The premium is calculated on a percentage of wages for the time worked and not for the time saved. This gives more bonus to the workers. It is calculated by the following formula:
DU SOL B.Com 3rd Year Human Resource Management Notes Chapter 15 Performance Linked Compensation (Variable and Incentive Wage Plans) 2
Thus, if the worker finished the job in 15 hours for standard time of 20 hours and the hourly rate of wage is 60 paise, a worker will get a total of Rs. 11.25 as follows –
DU SOL B.Com 3rd Year Human Resource Management Notes Chapter 15 Performance Linked Compensation (Variable and Incentive Wage Plans) 3


  1. The total bonus earned does not increase in the same proportion in which efficiency increases and thus there is no possibility of over speeding.
  2. There is less cost of supervision.
  3. The plan is good for beginners and learners.
  4. There is no inducement to the worker to rush through the work.


  1. No difference is made between efficient and inefficient worker.
  2. It is difficult for the workers to understand.
  3. As the time saved increases (or efficiency increases), the bonus will be a decreasing proportion.

3. Taylor’s Differential Piece Rate System – As a part of scientific management, this plan was devised by Taylor with a view to provide greater incentives to efficient workers. Under this plan, a standard task is established by the techniques of time and motion study and two piece rates are set up for each job.

A high piece rate is allowed to those who can make equal to or higher than the standard performance; and a lower piece rate for those who cannot reach the standard. Thus, this mqthod penalises the slow and lazy workers and pays incentive to efficient workers.


  1. It makes a distinction between efficient and inefficient workers. Lazy and inefficient workers are penalised, while efficient workers are rewarded.
  2. The basis of this system is scientific. It is based on proper work study.
  3. It helps in spotting and eliminating inefficient workers.


  1. A worker missing the standard even by narrow margin is penalised heavily.
  2. It is more mechanical and less humane.
  3. Trade unions oppose this plan.
  4. It may lead to discontentment among workers.
  5. There is no guaranteed minimum wage.

4. The Gantt Task and Bonus Plan – H.L. Gantt, an associate of Taylor, devised this scheme on the basis of Taylor’s plan. Under this scheme, fixed time rates are guaranteed. Output standards and time standards are established for the performance of each job. Workers completing the standard job within the standard time or a shorter time receive wages for the standard time plus a bonus. The bonus is a percentage, varying from 20 to 50, of the wage for the standard time. When a worker fails to turn out the required quantity of products, he simply gets his time rate without any bonus.


  1. It is simple and easily understood.
  2. It guarantees day wages and also provides incentive to efficient workmen.
  3. The employer derives the benefit of decreasing it with higher output.


  1. If the minimum wages are kept high due to union pressure, there will not be much incentive for better performance.
  2. Labour cost is high for low production and also up to standard output because of guaranteed day wages and bonus.
  3. The scheme is preferred by the totally inefficient workers as well as by the most efficient workers. Reasonably efficient workers cut a sorry figure.

5. Emerson’s Efficiency Bonus Plan – This plan has been named after Harrington Emerson; the innovator of this plan. Under this plan every worker is guaranteed his day wages irrespective of his performance.

A standard output is fixed, and represents 100% efficiency. According to the plan up to 662/3% of the efficiency guaranteed time wages are paid to the workers, after this they are paid bonus at stated ratio of the time wages.

Emerson used 32 empirical bonus percentages for efficiency beyond 662/3% under this plan, the bonus starts from 0.01 % above 662/3% efficiency and increases to 20% at maximum efficiency. After this point the bonus is 20% above the basic wages plus 1% for each 1% increase in efficiency.

Advantages (Merits) of Emerson’s Efficiency Plan:

  1. Beginners are encouraged to work hard under this plan.
  2. Proper attention is paid to different kinds of workers.
  3. It is easy to understand the Emerson’s Plan. ‘
  4. It possesses rational determination of efficiency.
  5. The calculation of efficiency is logical.
  6. This plan can be applied to individual tasks as well as group tasks.

Disadvantages (Demerits) of Emerson’s Efficiency Plan:

  1.  Labour cost is increased due to payment of bonus on low level of production.
  2. There is low rate of bonus in the beginning.
  3. It is a complicated plan as far as calculation is concerned.
  4. It requires a lot of clerical work.
  5. Under this plan, management may be tempted to fix a very high level of standard output.

6. The Bedaux Points Premium Plan – Under this plan, Standard time is divided into Standard minutes. Each minute of standard time is called Bedaux point or B’s. B’s are indicated on each job ticket. Time wages are paid until 100% efficiency is reached. Bonus is paid on the basis of number of v Bedaux Points saved. Bonus at 75% of wages of Bedaux saved is paid to the worker and 25% is paid to the .foreman.


  1. Minimum wages are guaranteed to the workers, even if they are not able to complete their job within the standard time.
  2. Since 25% of the wages for time saved goes to the foreman, he is motivated to get higher productivity from the workers.
  3. It is suitable where a worker is expected to perform a number of different jobs.


  1. Calculations are complicated and workers are not able to understand it and it involves heavy clerical expenditure.
  2. Workers do not like that foreman should share their bonus.

7. Merrick’s Multiple Piece Rate Plan – It is an improvement over Taylor’s Differential Plan. According to this plan, three piece rates for a job is fixed. None of these three piece rates are fixed below the normal level.
These three rates are applied in the manner given below.
Rates    –  Bonus Incentives
1. Upto 83 1/3% – Normal Rate
2. Above 83 1/3%to 100% – 110% of Normal Rate
3. Above 100% – 120% of Normal Rate


  1. This plan is liberal for the efficient workers. The workers producting more, get their wages at increasing rates.
  2. There is no sudden rise in the wages at one point.
  3. It has all merits of Taylor’s Differential plan.


  1. The system does not guarantee minimum wages for the workers.
  2. There is wide gap in slabs. All workers producing 1% to 83% of the standard output are considered as sub-standard workers and are paid at the same piece rate.
  3. The general criticisms levelled against Taylor’s plan also apply to it.

B. Group Incentive Wage Plan – These are the incentive wage plans which motivate the group to produce more under individual incentive plans, bonus is paid to the workers on the basis of individual performance and the amount of bonus payable to a worker is not affected by the performance of i another or other workers. But there are certain situations where it is difficult to measure the output of an individual worker conveniently or the performance of one worker is affected by the performance of other workers.

In such situations, group incentive bonus schemes are introduced. Under this scheme, bonus is made payable to all. workers on a collective basis. This bonus is promised by the management in advance of the commencement of work for securing effective teamwork. In all cases, a fixed standard of performance is established and the bonus is given for the results shown over the standard performance.


  1. It creates a collective interest in the work.
  2. High output and economical production is achieved.
  3. Jealousy among workers is prevented.
  4. It ensures better cooperation and team-spirit and reduction in absenteeism.
  5. Routing and scheduling are simplified. ,
  6. It reduces cost of supervision, cost of calculation of bonus and wastages.


  1. An individual worker may not put his maximum effort in view of equal sharing of bonus by inefficient workers. ‘
  2. Individual efficiency is not taken into account. ’
  3. There is difficulty in calculation of bonus to all workers in the group.

Suitability – Group incentive wage plan is most suitable in the following cases:
(a) Where it is not possible to measure the performance of each individual worker.
(b) Where the number of workers making a group is not very large.
(c) Where the workers making a group, possess the same or equal skills and abilities.
(d) Where the aim is to provide incentives to indirect workers.
(e) Where the finished product is the result of collective efforts of a group.

Types Of Group Incentive Schemes:
There are different types of group incentive shcemes. Important among them are as follows:

1. Preistman Plan – This system of wage payment was first used by Priestman’s of Hull in 1917. It was applied to workers who work in groups. ‘ It provides for payment of group bonus in addition to the ordinary time rate to the individual workers.

Thus if during a year, an enterprise is able to reach the predetermined standard output or exceed the previous year’s output, workers are paid increased wages in the same ratio in which output has increased. For example, if in 1990, the output per worker-hour was 10 units and in 1991, it rises to 11 units per worker-hour, the wages in 1991 would be 10% higher than those in 1990.

An advantage of the system is that it brings about team-spirit among the workers of a group. If the group as a whole works well, this is bound to add to overall output of the enterprise and in that case all the workers would stand to benefit.

But its disadvantage is that it may be insufficient to motivate individual workers, particularly those who possess greater skills and experience.

2. Scanlon Plan – Named after Mr. Joseph Scanlon of United States, this plan is the most popular for sharing the gains from increase in.productivity. It provides for payment of 10% participating bonus for every 10% increase in productivity. The benefit is extended to all employees except the members of top management.

Under the plan, workers are not paid the entire amount of bonus earned by them in any month. One half of the first 15% of such bonus is set apart for the creation of a reserve fund. This fund is used to neutralize the effects of any fluctuations in labour costs. In case a part of such fund remains unused, it too is distributed among the workers in the last month of the year and then a new fund is a created for the new year.

3. Productive Bargaining – Management and workers of an enterprise may reach an agreement under which workers agree to give up unproductive wasteful practices such as go-slow and work to rule and in return, the management agrees to link the wages and concessions of increase in productivity.

For this, it is necessary that there should be a strong trade union to force the workers to honor the agreement. In case there are too many unions not cooperating with one another such agreement has little chance of succeeding

4. Profit-Sharing – The aim of profit sharing is to give the employees an incentive to increase their output as also bring about healthy and beneficial employer employee relationship. [For details, see question]

5. Employee Stock Option Plan (ESOP). Under this plan, certain eligible employees are given an option to purchase organisation’s stock (equity shares) at reduced price. Eligibility is determined by way level or length of service or both. (See. question)

Question 5.
What do you understand by profit sharing ? Describe its merits and demerits.
Meaning, Merits And Demerits Of Profit Sharing
Profit-Sharing Scheme:
According to Prof. Seager “profit sharing is an arrangement by which employees receive a share, fixed in advance of the profits.” The International Co-operative Congress 1889 defined profit sharing as “an agreement (formal or informal) freely entered into, by which an employee receives a share fixed in advance of the profits.” Profit sharing usually involves the determination of an organisations’ profits at the end of the fiscal year and the distribution of a percentage of the profits to workers qualified to share in the earnings.

The following are the main features of profit sharing:

  1. There is mutual sharing of the profits between the owners and the workers on the basis of an agreement between the two. They do not share the losses.
  2. The payment arising from profit sharing is over and above the normal wages paid to the workers.
  3. The payment is made after ascertaining the net profits of the company. Thus it is not a part of the cost of production or a charge on profits.
  4. The payment is made only when the profits cross a certain level.
  5. The payment is based on seniority and or wage level of each individual employee.
  6. The payment represents a reward for group-effort and efficiency and is made” to all grades of employees.

Aims of profit sharing:
The aims of profit sharing may be summarised as follows:

  1. It supplements the earnings of workers and thus, at least partly, bridges the gulf between the fair wage and actual wage.
  2. It gives the workers an opportunity to share in the prosperity of the firm for which, to a large extent, they are themselves responsible.
  3. It seeks to reconcile the interests of the management and workers and promotes mutually beneficial partnership between them.

How management and workers view it:
The aim of profit-sharing schemes has been partly to give the employees an incentive to increase their output and partly to promote good relations between the management and labour. For this reason it ought to be favoured by both.

But the reality is quite otherwise. If the employers are too reluctant to extend any such benefit to workers, workers on their part look to it with suspicion and, even when accept it, they give the impression as though it is their birth-right to receive it.

As management sees it – Wages, like other prices, are determined in a market, in this case the labour market. Like water, wages find their own level. In any case, a firm’s ability to pay wages is determined by its capacity to create demand for the goods and services produced by it.

No doubt, a firm earning profits can affort to pay higher wages. But, profit or no profit, why should a firm pay more than the wage rates prevailing in the labour market ?

And if despite such a strong case against the payment, the mangement agrees to a profit sharing plan, it deserves to regarded as an evidence of its benevolence towards’ workers. In return, it has every right to expect the workers to be loyal and devoted to it, and not fall under the influence of trade union leaders.

As workers see it – For workers, a profit-sharing plan represents the fulfilment of their legitimate demand for a share in the prosperity of the firm. If the firm is able to make profits, it is mainly because of the efforts and cooperation by workers. As such, they refuse to regard profit sharing as a concession extended to them by a benevolent management.

In fact workers regard it as a deferred wage i.e., a wage which is their legitimate due but whose payment is with need for a stated time. Hence bonus should be regarded as a part of the cost of production.

1. Healthy employer-employee Relations – An important advantage of profit sharing is that is promotes healthy employer-employee relations. Workers take their work seriously and dislike the idea of going on strike.

They know that doing so would have an adverse effect on the profitability of the enterprise with the result that their own share in it might also decline. Thus instead of labour unrest. There is a community of interests of both- workers and employers.

2. Increase in Productivity – Because workers develop an interest in the increased profits of the enterprise, they accomplish their tasks more efficiently. They realise that low productivity or rise in production costs, would mean lower profits and therefore lower rates of bonus for them. They make every effort to increase production.

3. Additional Earnings for Workers – Profit sharing results in additional earnings for workers because the payment under it is in addition to normal wages.

4. Reduction in labour turnover – Payment under a profit sharing plan is largely based on the length of service of a worker. Thus, to be eligible for higher bonus an employee has to work for the enterprise for a sufficiently long duration.

An employee who changes his employer frequently loses his right to receive profits. Thus profit sharing plan encourages workers to stick to their present jobs.Thus resulting in reduced labour turnover.

5. Less Supervision – Since workers develop an interest in the profitability of the concerned. They do not need much supervision to make them work hard. Even without supervision they accomplish the tasks to the best of their abilities.

6. Equity and Social Justice – A profit-sharing scheme results in equitable distribution of profits among owners (haves) and workers (have- not). Just as increased profits lead to increase dividends. For share holders, there are increased earnings also for the employees of the enterprise. Thus owners and employees are put on an equal footing which serves the cause of social justice.

7. Selection of Better Personnel – Operation of a profit-sharing plan acts as inducement to qualified personnel to join the enterprise as its employees.

8. Promotion ofTeam spirit – a profit-sharing plan encourages workers in each department to work unitedly as a team and to offer willing assistance in solving operating problems. They know that stoppage of work at any point may adversely affect the profitability of the enterprise and thus reduce their share in it. This generates a spirit of cooperation which leads to an all-round ‘ development of all those associated with the enterprise-entrepreneurs, employees, consumers and the community.

1. No Bonus in Case of Losses – A profit-sharing plan adds to workers earnings only in case the enterprise earns profits. If the enterprise does not make profits, workers do not get anything.

2. A drag on newly established concerns – In case of new enterprise it cannot correctly estimate its profits which in any case, may not be large enough to support any worth while profit-sharing scheme. Profit-sharing plan in such an enterprise may dry up its earnings completely.

3. Element of Uncertainty – Payment under a profit-sharing plan cannot “be taken for granted. Even when employees do their best, they may not get any benefit in absence of any profit earned by enterprise. Sometimes this may be due to factors beyond anybody’s control, for example depression, unfavourable business conditions, uncertain demand for goods and services produced by the enterprise etc.. Lack of profits may be because of mismanagement of the enterprise. Thus workers have to go without additional earnings for no fault of their own.

4. Deliberate suppression of Profits – Sometimes an unscrupulous management may resort to manipulation of the accounts to suppress profits so as to avoid payment of the worker’s legitimate share in the profits of the business.

5. Inadequate Incentive – Payment under a profit-sharing plan is made only one or twice in a year and therefore it does not have the same attraction as weekly or monthly incentive payments.

6. No distinction between efficient and inefficient workers – A profit sharing plan does not make any distinction between efficient and inefficient workers. This discourages and demoralises the efficient workers.

7. Opposed by Trade Unions – Profit-shafing plans are generally not liked by trade unions. This is because in return for payment under such a plan, management expects the workers to be more loyal to it and keep away from trade unions. Hence trade unions oppose this as an attempt to destroy labour unions.

8. Not liked by employers – Employers also oppose this scheme on the ground that they have to share their profit with the workers who, in their opinion, do little to deserve their share profits, according to the owners, represent the wages of management. If management has to sacrifice a part of their profits, there would be no incentives to undertake risks.

Question 6.
Give the salient features of employee Stock Option Plan (ESOP). and explain its significance
Write an explanatory note on employee stock option plan.
Employees Stock Option Plan (ESOP)
Employee Stock Ownership plans got its start in the USA around 1910. But the practice was discontinued after the great depression of 1930 by most of the companies. £fter recovery from depression stock option plan in different forms were introduced in the USA and are quite popular these days.

The stock option plan, according to Edwin B. Flippo is “‘the employee ownership or stock option plan provides a mechanism through which certain eligible employees may be purchase the stock of the company at a reduced rate.

” The eligibility is usually determined by wage level or length of service or both. Most of the firms offer their stocks to employees at a price which is 10 to 20 percent lower than the market price. The companies offer the stock for instalment buying. A deduction is made every month from their salary.

Stock option plans are specially designed for the executive. Under stock options plan, eligible executives are allotted companies shares (known as sweat equity) below the market price.

Features of the Stock Option Plan. The salient features of the stock opted plan are as under –

  1. Employee stock option plan is voluntary in nature.
  2. It offers an option to the employee to purchase a certain amount of stock or shares in the future at a stated price or in the present at a price lower than the market price.
  3. It intends to procure and maintain talented professional employees.
  4. It makes the employee a part owner of the company where he is working.
  5. It creates mutuality of interest between the company and the employee.
  6. Stocks are held in trust until employee chooses to withdraw from the plan or leaves the service.

Merits (Significance) of ESOP:
The ESOP can be used to serve several objectives. It provides a mechanism for employee’s participation in the equity of the company. The employees who are offered stock or shares feel committed to the company and work for the growth of the company. Because of the possibility of gains in future, their motivational level is increased. Some of the intended benefits of the ESOP are as follows –

  • The employees get an opportunity to attend the meetings of the company and have detailed information about the progress and future plans of the company.
  • It promotes mutuality of interest between the employer and employee. The employee is encouraged to consider the view point of the employer company. He reads company literature such as operating results, balance sheet and annual report which increases his knowledge about the company.
  • Workers income is supplemented by dividends.
  • It is tool of motivation of the employees, and make them loyal and committed to the organisation.
  • The management also gains because of better cooperation, lesser supervision, reduced labour turnover, improved industrial relations, better understanding on the part of workers, elimination of wastes and enhancement of efficiency.

Demerits of the ESOP:
One of the commonly cited objectives of ESOP is the mutuality of interests. However the ESOP may not be preferred by the employees/executives due to the following reasons –

  • The plan is not preferred by some of the employees as there is no guarantee about increase in the market value of the shares/stock of the company in the future.
  • As long as the share prices go up, the morale of employees is higher. When share prices go down, the employees are likely to plans the company. Thus, the plan is attractive during prosperity only.
  • Employee participation in company meetings, management and control sometimes may prove an interference rather than an aid to cooperation.
  • It is a very poor incentive plan because of indirect relationship between efforts and reward of employees, and remoteness and uncertainty of reward.

Employee stock option scheme (ESOS) in India:
Employee Stock Option Plans (ESOP) are very popular in the USA. However, in India there is no provision for the constitution of such plans. It was in 1998 that the Government allowed the launching of stock option plans by the software companies.

In 1998, the companies Act was amended to introduce the scheme in the name of Sweat Equity in Indian Companies subject to the guidelines issued by the Securities Exchange Board f India (SEBI). A new see 2 (15A) was added to define the Employee Stock Scheme as follows –

As per section 2 (15A) of the companies Act ‘Employee Stock option’ means the option given to the wholetime directors, officers or employees of a company which gives such directors, officers or employees the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price.”

Under this Scheme [Employee Stock Option Scheme (ESOS)] an option has been given to employee to purchase shares at later date, at a price lower than the current market price. In case of Employee Stock Purchase Scheme (ESPS) share are offered on the spot to employees at a discounted price. Employee Stock purchase scheme was made effective w.e.f. 19th June 1999; SEBI guidelines in respect of both the schemes [ESOS or ESPS)] are as follows –

  • It is a voluntary scheme on the part of the company to encourage participation of employees in the company.
  • A suitable percentage of issue can be reserved by the company for the issue of employees. However, under the existing guidelines, 5% of the new issue may be reserved for this purpose subject to a maximum of 200 shares per employee who agree to participate to the scheme.
  • The membership of the ESOS shall be reserved only to the permanent employee of the company.

DU SOL B.Com 3rd Year Human Resource Management Notes

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