How a company can afford to give away so many shares as part of its ESOP

Question

As part of an employee share ownership plan (ESOP), the employee(s) get a certain # of shares held in their name. Every month, the employer also matches the contribution and let us assume the employee stays with the same employer for 30 yrs and never sells his or her shares.

My question is:

How can the employer find so many 'shares' to give away to so many employees every paycheck? If none of the employees sell their shares, it seems the only option that the employer has is to keep dividing the company into more number of shares, which cannot go on forever. I am assuming that these shares are common shares, but am not sure if that assumption is true?

If the employer cannot just keep 'creating' more shares, the only option is to buy shares back in the secondary market (assuming a public company). But even that is not possible because after a certain point, people in open market may not wish to sell their shares back to the company.

So where do shares issued to employees come from?

Answer 1

This question is very open ended. But I'll try to answer parts of it. An employer can offer shares as part of a compensation package. Instead of paying cash the employer can use the money to buy up shares and give them to the employees. This is done to keep employees for longer periods of time and the employer may also want to create more insider ownership for a number of reasons. Another possibility is issuance of secondary offerings that are partially given to employees. Secondary offerings often lower the price of the shares in the market and create an incentive for employees to stay until the stock price rises. All of these conditions can be stipulated, look up golden handcuffs.

Usually stock gifts are only given to a few high level employees and as part of a bonus package. It is very unusual to see a mature company regularly give away large amounts of stock, as this is a frowned upon practice. Start ups often pay their employees with stock up until the company is acquired or goes public.

Answer 2

There are two sources for shares that employees buy through ESOPs.

1. A company can simply buy the shares on the open market. The company must pay for the stock, but the employee then pays the company for the shares. If employees get a discount on the ESOP shares, the company would pay for that percentage directly.

2. The company can choose to issue new shares. These new shares dilute the ownership of all the other current stockholders.

While #2 is common when companies issue stock options, I'd be surprised to see it with an ESOP. In most cases, employees are limited in the amount of their salary they can devote towards the ESOP. If that limit is 10% and the discount that the employees get is 10%, the cost on a per-employee basis would only be 1% of that employees salary, which is a small expense.

Answer 3

Companies theoretically have an infinite number of equity units at their disposal. Issuance must be approved according to its founding contracts.

If an equity is trading on an open market then the price of each unit issued in lieu of cash compensation is known. Even if an equity doesn't trade openly, bidders can be solicited for a possible price or an appraisal. This can be a risky route for the potentially compensated.

Market capitalizations are frequently generally approximately equal to the sales of a company. Salaries and wages are frequently generally two thirds of sales.

It is indeed expensive for the average company to compensate with equity, thus so few do, usually restricting equity compensation to executives and exceptional laborers. Besides, they frequently have enough cash to pay for compensation, avoiding transaction costs.

For companies in growth industries such as technology or medicine, their situations are usually reversed: cash constrained yet equity abundant because of large investment and dearly priced equities. For a company trading at a market capitalization multiplied by forty times the revenue, compensating with equity is inexpensive.