Chapter 16

Employee Stock Ownership Plan

Introduction
 No longer employees willing to stay in the same
company for unless they are satisifed with returns
they get from their jobs.
 This could range from better refund remuneration to

growth prospects to a better working environment.

 Employees too do not want to be stuck with

inefficient employees but would like to have the best

people around.
 One of the most common employees motivation and

retention method is through employees stock

ownership plan
Meaning of employee Stock
Ownership Plan
 “ An ESOP is programme that allows employees
to purchase stock in the companies they work
for.
 It confers on employees the right to share in the
wealth of the company and the right to exercise
some degree of control over the company
affairs.
 ESOPs can improve employees work efforts,
provide incentive for employees to stay a
company, and allow retiring owners to transfers
shares of stock to employees.
 An employees stock ownership allows
companies to share ownership with
employees without requiring employees to
invest their money
 With ESOP shares of the companies are

contributed to an ESOP fund on behalf of the

employees.
 An employee stock ownership plan (ESOP) is a

type of employee benefit plan which is

intended to encourage employees to acquire
stocks or ownership in the company.
 Under these plans, the employer gives certain
stocks of the company to the employee for
negligible or less costs which remain in the
ESOP trust fund, until the options vests and
the employee exercises them or the employee
leaves/retires from the company or
institution.
 ESOPs provide a market for the shares of

closely held business, motivate great

employees productivity and provide tax
advantages in the financing acquisition.
How it is work
 To establish an ESOP, a corporation first establishes a
trust in which the company's employees are partial
owners.
 The employees then make contributions to the trust
via the employer (this is usually done through payroll
deductions).
 The trust in turn purchases shares of the company.
 These purchases are allocated to individual employee
accounts within the ESOP.
 Companies can allocate contributions to employees in
a number of ways, but they usually revolve around the
employee's years of service and compensation.
The need
 The nee of an ESOP is based on two
principles, viz. Macro and Micro.
 Macro Principle
 The purpose of the employees ownership is

to provide a means by which the mass of the

employees can become direct co owner of the
business where they work.
 ESOP preserves both of these principles. It

does so providing Employees with the means

to purchase pr
Micro Principle
 Productivity: Employees share ownership is
identified as a means of enhancing enterprise
performance through promoting worker
productivity.
 Saving: The long term shortage of saving in

an ageing community ,seems to require the

development of more supplicated approach
to national savings policy.
 Investment: ESOP provide employees with a
way of participating in buy in buy outs and of
financing in return for equity, the capital
expansion of business.
 Human Resource Management: There is range
of industrial relations or human resource
management rationales for employees share
ownership.
 ESOPs is a means of increasing employees
understanding how the company for which
they work ,operates and more broadly of
absorbing principle on which the econoy
country is run
Types of ESOPS
1.Non Leveraged ESOP
 This first type of ESOP) does not involve borrowed
funds to acquire the sponsoring employer’s stock.
 It is funded by contributions of cash or stock directly

from the employer sponsor. Shares of stock contributed

by the corporation are “newly issued shares.”
 New shares are issued to the ESOP and a deduction is

taken by the corporation for their appraised fair market

value as of the date of contribution.
 Alternatively, cash can be contributed to the plan in

annual discretionary amounts as cash flow permits, to

purchase shares at a later date, or simultaneously, from
either the corporation or from another shareholder.
 A non-leveraged ESOP does not involve
borrowed funds to acquire the sponsoring
employer’s stock. It is funded by
contributions of cash or stock directly from
the employer sponsor.
 Non-leveraged ESOP simply refers to an ESOP

that does not use debt or leverage or

financing to buy stock. Sometimes a non-
leveraged ESOP is referred to as a stock
bonus plan. 
2. Leveraged Buyout ESOP
 An “Issuance ESOP” uses financing to acquire newly
issued shares from the employer sponsor.
 The shares are allocated to the participants’ accounts
as the loan is repaid.
 During this repayment, the shares are released from a
special ESOP account, called a “suspense account,” to
the ESOP participants’ accounts according to formulas
developed by the IRS.
 The corporate advantages of an Issuance ESOP are
that it creates tax advantaged financing for
purchasing capital goods, for expanding by merger or
acquisition, or simply by increasing capital formation.
 For whatever purpose, the principal borrowed
to buy the stock effectively becomes tax
deductible by virtue of it being repaid via
plan expense/contributions. The company is
therefore able to borrow money this way on a
fully deductible basis.
Tax Issues for Employees and Companies

(1) Share premium account

(2) Trust route
(3) ESOP for private unlisted companies
(4) Tax implications in the hands of the
employees
(5) Tax implications in the hands of the
company 
Advantages of ESOP,
 Capital Appreciation: Company sell some or
all their equity to employees and by doing so
convert corporate and personal taxs in to tax
free capital Appreciation
 Incentive Based Retirement : ESOP Provide

cost effective plan to motivate employees.

 Tax Advantages: Enables tax advantaged

purchasing of stock of retiring company

owner.
 Company Reduce its tax liability: A company
can reduce its corporate income tax based
and increase its cash flow and net worth by
simply issuing treasury stock.
 ESOPs give incorporation tax deductions with

no cash expenditure.
Disadvantages of ESOP
 Liquidity: If the value of the stock appreciates
substantially, the ESOP and or the company may
not have sufficient fund to repurchase stock.
 Complex: Theresa a lot to learn when setting up

an ESOP and this can be a deferent for Same.

 Excessive leverage: To initially implement an

ESOP,The company may borrow money from an

institutional lender.
 Complicated Accounting: ESOP debt is recorded

as employer debt and this can be tricky for

accountants to grasp.