Employee Stock Options in Germany

Dirks, Nadia

Employee Stock Options in Germany

An exploratory study of employees perceptions on their use and effectiveness

von Nadia Dirks (Autor:in)

BWL - Investition und Finanzierung

Zusammenfassung

Inhaltsangabe:Abstract:
Companies located all around the world increasingly utilize stock options as a means of compensation for employees. Despite their widespread use it is still unknown why employee stock option plans are adopted, how their effectiveness is defined, and what influences their effectiveness. This masters thesis reports on an exploratory study undertaken on a sample of employees of the German IT company Network Appliance GmbH intended to answer exactly these questions.
The aim of this study was to explore in an in-depth, descriptive fashion, the perspectives of employees receiving stock options as part of their compensation as they are as participants in the process - best situated to provide insights into the practical implications on the use and effectiveness of employee stock options. The qualitative methodology of the study allowed for the opinions and experiences of the employees to be heard and a rich picture of their perceptions on employee stock options was attained. The qualitative content analysis revealed a number of goals, which are associated with employees perceptions on why employee stock options are a part of their compensation, and which factors influence these goals effectiveness. An exploratory model of the use and effectiveness of employee stock options has been deducted from these findings, which enables managers and researchers to obtain a better understanding of this means of compensation.
Even though research on compensation structures is typically explained by agency theory, the findings of this thesis suggest that no single theory provides a comprehensive explanation of the use and effectiveness of ESOs. Although the existence of a gap between employee and shareholder interests may lead some companies to adopt an employee stock option plan as suggested by agency theory, it is unlikely to be the only reason. Reality seems to be more complex than anticipated by guiding theory in this stream of research, therefore this study suggests that several theoretical frameworks complementing each other, such as human resource management, social exchange, tournament, social comparison, expectancy, managerial discretion, an institutional theory, are needed to fully grasp the use and effectiveness of employee stock options.

Inhaltsverzeichnis:Table of Contents:
Management SummaryII
ReferencesIII
Table of ContentsVIII
1.Introduction1
1.1Introduction1
1.2Problem indication1
1.3Problem2
1.4Research […]

Leseprobe

Inhaltsverzeichnis

ID 7298

Dirks, Nadia: Employee Stock Options in Germany - An exploratory study of employees'

perceptions on their use and effectiveness

Hamburg: Diplomica GmbH, 2003

Zugl.: Tilburg University, Universität, MBA-Thesis/Master of Business Administration,

2003

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Management Summary

Companies located all around the world increasingly utilize stock options as a

means of compensation for employees. Despite their widespread use it is still unknown why

employee stock option plans are adopted, how their effectiveness is defined, and what

influences their effectiveness. This master's thesis reports on an exploratory study

undertaken on a sample of employees of the German IT company Network Appliance GmbH

intended to answer exactly these questions.

The aim of this study was to explore in an in-depth, descriptive fashion, the

perspectives of employees receiving stock options as part of their compensation as they are

- as participants in the process - best situated to provide insights into the practical

implications on the use and effectiveness of employee stock options. The qualitative

methodology of the study allowed for the opinions and experiences of the employees to be

heard and a rich picture of their perceptions on employee stock options was attained. The

qualitative content analysis revealed a number of goals, which are associated with

employees' perceptions on why employee stock options are a part of their compensation,

and which factors influence these goals' effectiveness. An exploratory model of the use and

effectiveness of employee stock options has been deducted from these findings, which

enables managers and researchers to obtain a better understanding of this means of

compensation.

Even though research on compensation structures is typically explained by

agency theory, the findings of this thesis suggest that no single theory provides a

comprehensive explanation of the use and effectiveness of ESOs. Although the existence of

a gap between employee and shareholder interests may lead some companies to adopt an

employee stock option plan as suggested by agency theory, it is unlikely to be the only

reason. Reality seems to be more complex than anticipated by guiding theory in this stream

of research, therefore this study suggests that several theoretical frameworks complementing

each other, such as human resource management, social exchange, tournament, social

comparison, expectancy, managerial discretion, an institutional theory, are needed to fully

grasp the use and effectiveness of employee stock options.

III

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VII

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VIII

Table of contents

Management Summary II

References

III

Table of Contents VIII

Chapter 1 Introduction

1.1 Introduction

1.2 Problem

indication

1.3 Problem

1.4 Research

questions

1.5

Structure of the thesis

Chapter 2 Employee

stock

options

2.1 Introduction

2.2

What are employee stock options?

2.3

Types of ESOs

2.4

Origins of ESOs

2.5

ESOs in international markets

2.6

ESOs in the German market

2.7

The fiscal situation for ESOs in Germany

2.7.1

Taxation of the employee

2.7.2

Tax deduction in the company

2.8

Case study Network Appliance

2.8.1

ESOs at Network Appliance GmbH

2.8.2

Outline of the stock option plan

2.9 Conclusion

Chapter 3

Theories explaining the use of ESOs

3.1 Introduction

3.2

Agency theory as the traditional explanation

3.2.1

The two typical agency problems

3.2.2

Agency theory and ESOs

3.3 Non-traditional

explanations

3.3.1

Human resource management theory

3.3.2

Social exchange theory

3.3.3

Tournament

theory

3.3.4

Social

comparison

theory

3.3.5

Expectancy / Managerial discretion theory

3.3.6

Institutional

theory

3.4 Conclusion

Chapter 4

Research design

4.1 Introduction

4.2 Research

method

4.3

Sample of participants

4.4 Data

collection

4.5 Operationalization

4.5.1

Structure of the questionnaire

4.5.2

Translation

technique

4.6 Summary

Chapter 5 Research

results

5.1 Introduction

5.2

Characteristics of the sample

5.3 Data

analysis

5.3.1

Methodology

5.3.2

Reliability

and

validity

5.3.2.1 The three types of reliability

5.3.2.2 The two types of construct validity

5.4

Findings and interpretation

5.4.1

ESOs as a retention tool

5.4.2

ESOs as a motivation tool

5.4.3

ESOs as a tool to minimize costs

5.4.4

ESOs as a recognition tool

5.4.5

ESOs as competitiveness tool

5.4.6

ESOs as an engagement tool

5.4.7

ESOs as a tool to control shareholders

5.4.8

ESOs as a market requirement

5.4.9 Seldom-mentioned

reasons

5.5 Summary

Chapter 6

Conclusions and recommendations

6.1 Introduction

6.2 Conclusions

6.3 Implications

for

managers

6.4

Limitations and further research suggestions

References

Appendices:

- Questionnaire

(English

version)

- Questionnaire

(German

version)

Tables 1 10: Ranking and rating of goals 1 - 8

Cohen's Kappa estimations

Chapter 1:

Introduction

1.1 Introduction

The trend of using stock options as long-term incentives for employees, originated

in the U.S., is increasingly being adopted in the European market. Even though the dramatic

growth in the use of stock options to compensate employees represents one of the most

significant compensation trends of the past decade, research ceased to fully explain this

phenomenon so far.

1.2 Problem

indication

According to Bloom and Milkovich (1998), the principal theory guiding

organizational research on compensation structures as well as the pay for performance

relationship is the agency theory. Hence, a great variety of research has been conducted in

the field of compensation using agency theory to explain several phenomena. However,

researchers have reached few firm conclusions about whether or not organizations award

stock options to their employees in accordance with agency theory. Therefore, it appears that

there are three main areas for further research in this field:

First, it has been argued by several researchers (e.g., Eisenhardt, 1989) that

agency theory only presents a partial view of the world and does not grasp the complexity of

organizations and additional perspectives. To overcome this problem it has been

recommended to use agency theory with complementary theories to explain a certain

organizational phenomenon. In addition, recent research in the field of human resource

management has discovered that employee stock options are increasingly used as a tool to

attract and retain employees (e. g., Pfeffer, 1994; Wright et al., 1994). Thus, there is a need

to add new insights to the traditional paradigm of the compensation literature by explaining

the use and effectiveness of ESOs not only with agency theory, but also with human

resource management theories and other non-traditional theories.

Second, it has been pointed out by several researchers (e.g., Barkema & Gomez-

Mejia, 1998; Yeo, et al., 1999) that "much of the existing literature on ESOs focuses on US

data and thus, may only reflect the specific environment in the U.S". Very little is known

about the use of ESOs in other countries and "data on other countries represent a rich,

virtually untapped, source of increased understanding of what determines compensation".

Hence, there is a need for research to take into account the increasing international use of

ESOs and add on to the current knowledge in that field by focusing on countries other than

the U.S.

Finally, prior research has mainly focused on the disclosed information about

ESOs in annual reports, data bases and other public information about companies. However,

as most companies do not disclose much information of this kind (this is even less outside

the U.S) it is felt that a greater variety of more authentic information might be retrieved by

focusing on employees receiving stock options as part of their compensation as the main

source of information.

1.3 Problem

The general research problem can thus be stated:

· How do German employees perceive the use and effectiveness of employee

stock options (ESOs) and how far can these perceptions be explained by the

agency theory or other perspectives?

1.4 Research

questions

In order to fully explore this general problem a number of research questions were

investigated:

1. What are ESOs and what are their special features in Germany?

2. How does agency theory explain the use and effectiveness of ESOs?

3. Which other theories could explain the use and effectiveness of ESOs?

4. Which goals do German employees perceive companies to pursue with ESOs?

5. How effectively do German employees perceive these goals to be reached with

ESOs?

6. Which factors do German employees perceive are determining the effectiveness

of ESOs?

7. Which of the theories discussed in research questions two and three match the

"real world" perceptions of German employees?

1.5

Structure of the thesis

In its first chapter the topic of this master's thesis is introduced and the relevance

of the research is explained. Further, a problem statement is devised and the research

questions are formulated. Finally, the structure of the thesis is explained.

The second chapter aims at answering research question one by explaining what

ESOs are, how they function and what different forms they can take. It further explains their

origin, international development and use, particularly in Germany, using the IT company

Network Appliance as an exemplary case study.

The third chapter reviews existing literature and research on incentive schemes.

Additionally, it analyses theories that have not previously been used in the field of ESOs and

which could complement to the traditional paradigm. This chapter aims at answering

research questions two and three.

Chapter four outlines and justifies the research design by elaborating on the

research method of the data gathering, the sampling of participants, the data collection and

the operationalization of the questionnaire.

Chapter five explains the data analysis, the methodology of this research, and it

further discusses its reliability and validity. It also aims at answering research questions four

to six by describing the findings of the data analysis and interpreting them.

The sixth chapter aims at answering research question seven by

drawing conclusions from the research. Finally, implications for both further research and

managers are generated and the limitations of the thesis are discussed.

Chapter 2:

Employee stock options

2.1 Introduction

The compensation of employees has become a complex matter as there are

many different forms of compensation tools and structures nowadays. However, no matter

the tools and the structure there is always some kind of a base pay or salary and on top of

that there are usually several kinds of short and long-term incentives.

Short-term incentives are variable performance awards, such as bonuses,

payable most often in cash. They are based on the actual performance of an employee

during a previously specified, relatively short (no longer than one year), period of time

compared to the pre-determined goals for that period, which are usually related to specific

corporate, business unit and individual targets.

Long-term incentives are performance-driven rewards that cover periods

exceeding one year, usually between three and five years, which may be based on internal

company performance targets, peer company comparisons, or some aspect of stock price

appreciation or shareholder return. Awards under long-term incentive plans usually are

based on the achievement of "target" multi-year performance goals, with a higher payout if

that target is exceeded and less payout for performance below target, or zero payment

should performance fall below a minimum "threshold" level. Examples for long-term

incentives are restricted stock grants, performance share plans and ESOs.

2.2

What are employee stock options?

An employee stock option is a financial derivate that gives its holder (the

employee) the right to purchase a stated number of the underlying shares (the company

common stock) at a predetermined price (exercise price) over a specified period of time.

Hence, ESOs are an opportunity for employees to become a shareholder of the company

they work for.

Companies that offer this benefit typically allow the employees to lock in the

purchase price for the stock either at or below the market price at the time the options are

granted. When the employees exercise their option their return corresponds to the difference

between the current stock market value and the prior set price of the option. Thus, it is

favorable for the employee to enjoy high stock prices while the exercise price of the options

is relatively low. In addition, it should be noted that employees do not have to pay a premium

for the options as they receive them "for free" from their company. Hence, their return is

higher than with a normal (call) option. ESOs further differ from listed (call) options in that

there is usually a minimum holding period required before the options can be exercised and

that they cannot be exercised all at once. Finally, ESOs are long-term in nature (typically ten

years) and are strictly non-marketable.

In most companies ESOs are awarded once each year by a compensation

committee of the board of directors, acting under the authority of periodic shareholder votes.

Compensation committees exercise discretion over the size and timing of ESOs, thus, these

parameters vary substantially across companies and over time. Nevertheless, Duffhues

(2000) observes that there are generally two different ways of granting ESOs, as they can be

granted ex ante or ex post of a performed effort. Ex ante means that an employee receives a

certain amount of stock options on his or her recruitment in advance of the from him or her

expected efforts, whereas ex post means that an employee is granted a certain amount of

stock options after he or she has performed extremely well.

2.3

Types of ESOs

There are two basic kinds of ESOs, namely incentive stock options (ISOs) and

nonqualified stock options (NQSOs), which have some critical differences between them

affecting their flexibility.

ISOs are the less flexible kind of ESOs as there are several rules attached. First

of all ISOs must be granted for a term of 10 years or less. Secondly, they generally cannot

be exercised for less than 100 percent of the stock's fair market value at the time of the

grant. In addition, in most cases no more than approximately $100,000 worth of these

options can be exercised per year. Finally, the stock cannot be disposed of earlier than two

years after the options are granted or one year after they are exercised. However,

employees leaving the company generally must exercise their options within three month of

the date of departure. In most countries employees need not pay taxes on ISOs until they

sell the stock. At that time local tax rates, rules and regulations apply to the capital gains.

When the holding-period requirements are met the company receives no tax deduction. But if

an employee sells stock beforehand, he or she is taxed at ordinary income tax rates and the

company receives a corresponding tax deduction.

The second type of ESOs is more common among IT companies and start-ups as

it is more flexible than ISOs. This is due to no limitation on the amount of stock that can be

optioned or on the period in which the option can be exercised. In addition, the option price of

the stock may be less than 100 percent of the fair market value on the date of the grant.

In most countries there is no tax liability when NQSOs are granted. In general, employees

must recognize income and pay taxes only when the options are exercised. Also, the

company receives a tax deduction for the amount of income recognized by the employee,

and the tax benefit of the deduction is credited directly to the company's capital account.

2.4 Origins

ESOs

In the 1980's and the early 1990's many activist shareholders and experts in

corporate governance in the U.S. called for the spread of incentive pay. In response to broad

criticism that top executives were paid like bureaucrats, companies started using ESOs and

other long-term incentives to put much of their pay at risk.

In the U.S. ESOs are growing as a percentage of shares outstanding at

companies. Of the 200 largest companies in the U.S., options represented 11.8 percent of

the shares in 1997, compared with only 6.9 percent in 1989, according to Bryant (1998). 23

of those companies, including Morgan Stanley, Travelers, Warner-Lambert and Microsoft,

put more than 20 % of all shares aside for stock-related incentives. Bryant further estimated

that the total value of the shares set aside for options at all public companies of the U.S. had

risen in 1998 to approximately $600 billion from $60 billion in 1985.

2.5

ESOs in international markets

In 1997 only the U.S., Canada, the U.K. and a few other countries had long-term

incentive plans. Today companies all around the world make long-term incentive plans a

central component of total compensation (see figure 1).

Figure 1

Estimated percentage of companies offering long-term incentive plans in the

years 1997, 2001 and 2003 (Alcobe-Fierro, 2001).

Internationally, ESOs are becoming the central feature of long-term incentive

plans. A recent survey of Alcobe-Fierro (2001) documents the rapid, worldwide growth in

ESOs, examining compensation practices among large, local companies headquartered in

22 countries. The findings were that regardless of the type of company, stock options are

much more widely used than performance plans, restricted stock plans and other long-term

incentive programs in most countries (see figure 2).

Figure 2

Estimated percentage of companies with long-term incentive plans that utilized

ESOs in 2001 (Alcobe-Fierro, 2001).

Alcobe-Fierro (2001) further documents that this international trend of using ESOs

as long term incentives was originated by large, U.S. based companies expanding their long-

term incentive plans outside of the U.S., driven in part by a desire to motivate their global

leadership teams. Due to this, large companies headquartered outside the U.S. also started

moving in the same direction with their compensation programs. Alcobe-Fierro (2001) states

that many of these companies said that they felt compelled to adopt stock option plans

largely to counter the competitive pressure of the U.S. based multinationals and that in a

smaller number of cases, companies cited competitive pressure from their national peers as

well.

2.6

ESOs in the German market

Compensation in Germany traditionally comprises of salary and bonus, and the

use of ESOs as an additional compensation means used to be outlawed and discouraged in

Germany. This was due to the fact that the German culture is a collectivistic one

(Trompenaars, 1993), which means that performance-related pay does not fit well into the

German culture. Müller (1999) states that there is a traditional dominance of job-based pay in

Germany and that performance-related pay is less important.

Nevertheless, it appears that the ideology of performance-related pay has had

some impact on German managers after all and is recently starting to emerge. A growing

importance of performance-related pay in German firms has also been identified by Brewster

and Hegewisch (1994) and Weber and Kabst (1996). Hence, in recent years, following the

trend from the U. S., an increasing number of listed and unlisted joint stock companies in

Germany have introduced long-term incentive schemes and are offering ESOs to their

employees as an additional component of the compensation system.

2.7

The fiscal situation for ESOs in Germany

While in most countries ESOs are taxed, either at exercise or sale, at ordinary

income tax rates; in a few countries, such as the Netherlands and Switzerland, the option is

taxable upon grant. Hence, the requirements of taxation vary from country to country. As this

thesis focuses on ESOs in Germany in particular, only the German legislation on the matter

of taxation of ESOs will be further explained:

At present there are no particular rules on the taxation of stock options in German

legislation and the general rulings of the German Tax Code apply. As a result, many

questions are being gradually dealt with for the first time in case law at the German Federal

Tax Court, or remain pending. However, since May 1, 1998 there have been specific

company law amendments concerning ESOs in Germany. These will be explained first from

the employee and then from the company point of view.

2.7.1

Taxation of the employee

Benefits derived from ESOs are regarded as part of the employment income of

non-self-employed workers by the German Income Tax Law, which also applies to the

issuing of stock options by another affiliated company. This means that benefits are basically

subject to tax withheld from salary and with the above mentioned amendments the German

fiscal courts make the taxation of stock options dependent on whether the options are

granted as non-tradable options, or at the employees' free disposal.

As ESOs are usually granted as non-tradable stock options they are regarded as

a "valueless chance for a possible future profit". Therefore, tax liability arises not at the time

ESOs are granted but at the time they are exercised. Only at that time does the respective

employee gain a pecuniary benefit and has to pay taxes. The granting of ESOs, thus, makes

it possible for companies to grant no-cost stock options to their employees without

immediately creating taxable income.

Furthermore, the sale of ESOs or shares is also relevant within the private

taxation sphere. According to the German Income Tax Law, private asset sales are subject

to tax under certain exceptional circumstances. This applies to shares and stock options

when there is less than one year between the time of acquisition and sale. In this case, half

of the sales profit is to be taxed.

2.7.2

Tax deduction in the company

Concerning tax deductions for German employers for granting ESOs, there is no

special legal ruling, which means that the general basic law applies. As mentioned before,

when the ESOs are ready to be exercised the employer has to offer the employee to

purchase shares of the company at a prior specified price. In order to be able to do so the

employer has to posses enough shares of the company, which means either new shares

have to be issued or shares have to be bought back from third parties. The general basic law

differentiates between these two methods:

Newly created stock has not been recognized by the financial authorities yet;

there is also no court ruling on this. The acquisition of one's own stock leads, in general, to a

tax-neutral event. Additionally, ESOs have presented, to date, regularly tax-deductible

personnel costs, but under the new ruling of the German Corporation Tax Law this appears

doubtful and it remains to be seen how this issue will be handled by the authorities in the

near future.

Details

Seiten
Erscheinungsform: Originalausgabe
Erscheinungsjahr: 2003
ISBN (eBook): 9783832472986
ISBN (Paperback): 9783838672984
DOI: 10.3239/9783832472986
Dateigröße: 1 MB
Sprache: Englisch
Institution / Hochschule: Tilburg University – Economics and Business Administration
Erscheinungsdatum: 2003 (Oktober)
Note: 1,0
Schlagworte: agency theory human resource management
Produktsicherheit: Diplom.de

Autor

Nadia Dirks (Autor:in)