Bonus, profit sharing and stock options are among the various measures to promote employees financial participation in the companies they work both in equity (stock options) and in profits (bonus and profit sharing). Giving say and stake to employees is part of an ongoing thrust towards democratizing the workplace. In actual implementation, however, companies enjoy several options and also face several problems.
The Twentieth century dictionary defines bonus as, la premium beyond the usual interest for a loan; an extra dividend to shareholders, a policy holder’s share of profits; an extra payment to workmen or others. Neither the Payment of Bonus Act, 1965 nor any other industrial law defines bonus.
The concept of bonus payment to workers is originated in India during the First World War in the cotton textile industry in Bombay and Ahmedabad in 1917. When the practice was discontinued in 1923, there was a general strike and the Government of Maharashtra appointed a committee headed by Sir Normal McLeod, the then Chief Justice of Bombay High Court to consider the nature and basis of payment of bonus in the cotton textile industry of Bombay. The committee observed that the cotton mills working in 1923, as compared to the situation in 1917, did not justify any payment of bonus. Thus a link between profits and bonus was established in early 1920s. During Second World War the payment of bonus resumed and continued till 1945. In 1942, the bonus dispute in General Motors (India) Limited, was referred for adjudication. In this case Justice Chagla observed that, it is almost universally accepted principle now that the profits are made possible by the contribution that both capital and labour make in any particular industry, and I think it is also conceded that labour has a right to share in increased profits that are made in any particular period. But the distribution of increased profits among workers is better achieved by giving of an annual bonus than by a further increase in wages. Wages must be fixed on the basis of normal conditions .The next year in the case of Standard Vaccume Mill Company the adjudicator held that, If large profits were made as a result of the abnormal war conditions, it was but fair that a small fraction of such profits should be given by way of bonus without whose labour and cooperation the profits could not have been made.
In 1948 the Government of India has appointed a Committee on Profit Sharing. The Committee observed that it was not possible to devise a system in which labour share of profit could be determined on a sliding scale varying with production and favoured trying out profit sharing bonus industry-cum-locality basis as (a) an incentive to production, (b) a method of securing industrial peace, and, (c) a step in the participation of labour in management.
In 1950 the Labour Appellate Tribunal held, in the case of Mill Owners Association vs. Rashtriya Mill Mazdoor Sangh, that, where the goal living wages has been attained, bonus, like profit sharing, would represent more as the cash incentive for greater efficiency and production. We cannot, therefore, accept the broad contention that a claim to bonus is not admissible where wages have (as in the case before us) been standardised at a figure lower than what is said to be the living wage. Where the industry has capacity to pay, and has been so stabilised that its capacity to pay may be counted upon continuously. It thus made a distinction between living wage and actual wages and held that bonus could be used to bridge the gap between the two.
Five years later, Justice Bltagwati of the Supreme Court of India upheld the tribunal judgement in the case of Muir Mills Company vs. Suti Mills Mazdoor Union; it is, therefore, that the claim for bonus can be made by the employees only if as a result of the joint contribution of capital and labour the industrial concerned has earned profits. If in any particular year the working of the industrial concern has resulted in loss there is no justification for bonus. Bonus is not a deferred wage. Because if it so, it would necessarily rank for precedence before dividend. The dividend can only be paid out of profits and unless and until profits are made no occasion, or question ran also arise for distribution of any sum as bonuses among the employees. If the industrial concern has resulted in a trading loss, there would be no profits of the particular year available for distribution of dividend; much less could the employees claim the distribution of bonus during that year.
Thus, profit was considered as a precondition for bonus. Several companies including, for instance, Tam Iron and Steel Company, Indian Iron 'and Steel Company, Bharat Tin Plate Company and Buckingham and Carnatic Mills - have adopted voluntarily profit sharing bonuses. Notwithstanding this, there have been a series of disputes and a spate of strikes over bonus issue, with workers and their unions contending bonus to be a deferred wage. In 1961 the Government of India constituted Bonus Commission. Based on the report of the Commission in 1964, Payment of Bonus Act was enacted in 1965 with a view to: (a) enforce statutory liability upon employers covered by the Act to pay bonus to employees in the establishments concerned, (b) define the principles for payment of bonus according to the prescribed formula, (c) provide for payment of a minimum and maximum bonus and linking payment of bonus with a scheme of set-of and set-on, and, (d) to provide machinery for the enforcement of the liability for payment of bonus. The legislation did not achieve the intended objective of minimising conflict on account of bonus. During the discussions before the Bonus Commission when the employers wanted a ceiling on bonus, the workers asked for a floor. With the result, the legislation provided for a minimum of bonus of 4 percent regardless of whether a company earns profit or not. Subsequently it was raised to 8.33 per cent (section 10 of the Act) which is equivalent to one month's wages. In effect, this meant 13 months wages for 12 months work, and thus bonus has actually become, at the minimum level, a deferred wage that bore no relationship whatsoever with either productivity or profitability. The ceiling remained at 20 per cent, but with a provision far bargaining production linked bonus (Section 31-A of the Act). There are instances in the public sector where sick industries had agreed to pay more than 8.33 per cent.
The government employees are not covered by the Payment of Bonus Act. Still they receive annual a certain amount over and above the salary fit loosely called bonus under either of the following two schemes: (a) ex gratia payment, (b) productivity linked bonus (PLB). Those who are covered under the PLB include those working in Railways, Posts and Telecommunications and productions units under the Ministry of Defence. Those who are not covered by PLB are given ex gratia payment fixed by government annually on ad hoc basis. The concept of PLB to employees in government services, including organisations mentioned above was not favoured by Bhoothalingam Committee (1978) on wages, incomes and prices. Still, the PLB scheme was first introduced in the Railways in 1979-80 and later extended to the other departments.
The PLB schemes have by now become a permanent features, and the norms of productivity subject to negotiation at periodic (usually once every three years) intervals. The functioning of these schemes was reviewed by a group of officers headed by Bazle Karim, Secretary (Coordination), Cabinet Secretie, as the Chairman. The IV Central Pay Commission observed that the Bazle Karim committee was of the view that government departments constitute a single infrastructure for the economy as a whole and that there should be no sense of discrimination resulting in demoralisation among them as a group when the service conditions are uniform all along. They suggested the evolution of a productivity linked bonus scheme for central government employees as a whole. There are, however, problems in considering productivity of government as a whole. The IV Central Pay Commission observed that, while there is nothing to prevent government from making such payment if it so desires, it is in the nature of a concession arising out of goodwill and cannot be claimed as of right. It cannot, therefore, be said to form part of a regular scheme of emoluments of employees to whom it is granted. The reality, however, is that in late 1990s when the Government conceded PLB revision for Railways, but not to posts and telecom, the latter went on strike and obtained the revision.
PROFIT SHARING
Profit sharing means paying employees a share of the net profits in addition to their wage or salary. It is payment of a dividend or a sum based on wage or salary, grade or seniority. It is supposed to be a stimulus for higher performance. Profit sharing is different from shareholding which is discussed in the next section under the head, employee stock options. Employees can become shareholders in a company by either or both of the following two ways: (a) when they offered and buy shares in the company where they work; (b) when they offered shares as a reward or incentive for better performance or seniority/loyalty or both.
Profit sharing is also different from gain sharing. Gain sharing of the kind proposed by Joe Scanlon called the Scanlon Plan fit provided for a share to the workers of the savings in input costs. This combines incentive payments with worker participation in decision making and rewards people not necessary for working hard, but for working smart.
Profit sharing can take a number of different forms: (a) cash, (b) deferred payments (distributed on a deferred basis, with the seam being invested in enterprise funds or in special funds for a specific period), (c) offered as equity.
Profit sharing, like incentives, should be in addition to regular wage, should not be consider as a substitute for it. However, economists like Weitzman consider that expected profit-sharing bonuses will substitute for the basic wage, lower wage rates and wage costs, reduce marginal cost of hiring and increase employment. Profit sharing is considered as a useful tool in stabilizing wage costs, and yet rewarding workers when they and the company perform better. In some countries, particularly, the U.S., profit sharing schemes competed with or became complementary to pension schemes. Tax policies favoured and exempted differed payments at the time of retirement. The usual mechanism is the creation of different profit-payment trust which invested the funds in interest carrying special bonds and released tax free payments to workers upon retirement.
Profit sharing is supposed to contribute to productivity, worker motivation, worker participation and wage flexibility. The results may be reflected either in higher output or better financial performance through savings in input costs. When employees receive payments based on company's financial performance they become aware and concerned about factors contributing to business success and the commonality in goal with reduce mutual antagonism, if any. Thus profit sharing is also considered to improve the general climate of employment and industrial relations.
To let employees feel and actually realize that they are getting their due share in profits requires transparency in book-keeping practices. As of now in quite a few enterprises, both in the public and the private sectors, balance sheets are considered by their employees as excellent pieces of fiction. In some companies there is a feeling that their managements tell one thing to their shareholders and the other the union leaders and the workers. In the absence of trust and transparency, doubts persist.
There are also some problems with profit sharing. Profit sharing being a group based scheme could result in the problem of free-riders. Some individual employees get reward without deserving it and a few others may feel that what they are getting as a share in the profits of the company is not in proportion to the contribution they made.
Even though profit sharing is gravy, and not a substitute to the wages or salary, some trade unions also consider that profit sharing being a variable payment shifts risk to the employees. In the case of employee share-ownership, employees are putting not only their jobs and incomes at risk, but also their savings. Companies Act in India provides for payment of upto 11 per cent of profits to the whole-time directors of the company. Justice Mohan Committee, which was set up to recommend pay revision for public sector executives, submitted its report in 1998 and recommended that perquisites and allowances beyond 50 per cent of pay should be linked to performance. It observed that, this performance related payments should be a function of profitability at the level of a particular enterprise and emoluments at the level of the individual executive. While it is not possible to think of definitive stipulations or ceilings in these spheres, the Committee believes that some norms would be desirable. It would be appropriate to suggest that such performance related payment should not, as a norm, exceed 5 per cent of the distributable profits in an enterprise. However, there would b e situations where distributable profits are not large enough for performance related payments that could suitably reward executives for turning around or significantly improving performance of an enterprise. Similarly, it would be appropriate to suggest that performance related payments should not, as a norm exceed 50 per cent of the basic pay of an individual executive. The Board should, of course, have the flexibility and discretion to go beyond this norm wherever necessary and appropriate but the justification for the relaxation should be explicitly recorded.
STOCK OPTIONS
Stock options are opportunities to buy stock at a set price, immediately or some time in the future. Employers offer stocks to their employees for several reasons such as the following:
Attraction
Retention
Motivation
Financial participation by employees in the wealth created through the joint efforts of management and labour or employers and employees
Commitment
Develop common purpose/ideology between employers and employees.
Performance based reward
Supplement retirement/social security benefits
Incentives for improved performance on a sustained basis. When employees become owners too they put not only their blood but also their sweat
Prevent hostile take over. It is expected by employees that shareholders will provide the hedge against unfriendly takeovers by other firms
Stock options are becoming familiar in view of the following:
The shift from industrial to information revolution. Knowledge workers expect say and stake.
Public policy in many countries favours giving employees a share in equity and profits. This is pursued in few countries through legislation and in many others it is encouraged through voluntary persuasion.
In the wake of disinvestments and privatisation of public enterprises, employees are offered shares with' a view to ease their opposition, if any, and also to give the workers a stake. This is also considered as an effort at redistribution of wealth.
Stock options can be introduced not only by publicly traded firms, but also by privately held firms. Stock options by foreign companies to national employees should be guided by national law and tax policies. If the citizens are prohibited from holding foreign assets, even if the foreign employer is willing to offer stock options, national laws and tax policies may impose restrictions and hurdles in the way of national employees accepting such offers.
A survey of experiences of industrialized countries and those in Central and Eastern
Europe by Daniel Vaughan-Whitehead et. al. (1995) revealed that: (a) the latter countries developed financial participation by workers as a part of the privatisation process with a view to soften the opposition to economic reforms, achieve redistribution of wealth, through not only private capital share-ownership but wider share-ownership by employees and citizen. Consequently, these countries developed share-ownership systems instead of profit-sharing schemes and as such they do not necessarily constitute a progressive evolution of their pay system or their work organization process. This does not mean that there are no similarities between experiences in Central and Eastern Europe and the industrialised Western Europe. For instance, both U.K. and France have used wider share ownership concept during the process of privatisation.
In some western industrialised countries, financial participation by employees is promoted through legislation. In U.K. and U.S.A. it is encouraged mainly through a variety of tax incentives for deferred profit-sharing schemes and employee stock option programmes. In Belgium and Italy it evolved through collective bargaining. In Japan it is highly decentralized and became a part of management policy than public policy and legislation. In most countries employers want profit sharing and employee stock options to be voluntary.
In India, during the 1980s a scheme was introduced by Mr., V. P. Singh, when he was the Finance Minister whereby 5 per cent of the new issues could be reserved for employees of the company. Over a decade later, the Securities Exchange Board of India (SEBI) issued the following guidelines, effective from June 1999 (a) all employees except promoters and part time directors are eligible to participate in employee stock option schemes (ESOS); (b) ESOS would be recommended in including terms and conditions and quantum, exercise price and period - by a compensation committee of Board of directors comprising majority of independent directors and approved by the by the shareholders through a special resolution; (c) the shares and convertible securities under the scheme may include American Depository Receipts and Global Depository Receipts. The guidelines also deal with valuation, funding and purchase of stocks.
In the past companies offered stock options to a handful of top ranking key managers. However, with the advent of information, the need to attract, retain and motivate workforce is making it imperative to give them both say and stake. In India mainly information technology and software firms introduced employee stock option plans. In recent years many FMCG (fast moving consumer goods industry) firms have also begun to offer stock options to their employees. Which companies in India have employee stock option plans? The prominent examples in India include Castrol, CRISIL, Global Trust Bank, Godrej-GE, HCL, and Infosys
Technologies, Mastek, MIT, Pentafour, Proctor and Gamble, WIPRO, Zee Network, etc. Several others are planning to introduce employee stock options. In several public enterprises employees are offered shares on special terms at the time of disinvestments and/or public offering. Initially trade unions in banks and several public enterprises resisted the idea of workers owning sharing because of ideological aversion to worker capitalism. However, trade union opposition to stock options weakened because many of their own members did not want to let the opportunity to go. Actually in several cases they asked for more shares than the government was initially willing to offer to the workers. In a quite a few cases workers have made a bid for taking over the enterprise through worker ownership.
While it has indeed happened in Jaipur Metal Works, Kamani Tubes and New Central Jute Mills in others like the Indian Petrochemicals Limited and one of the units of Philips in Calcutta it did not quite materialize.
Tax Treatment of Stock Options
While bonus and profit sharing earnings of employees are deductible expenses for companies and taxed in the hands of the employees the tax treatment of stock options is somewhat different. At present stock options is tax as perquisite when option is granted at discounted prices. They are also taxed as a capital gain when they are converted into cash. Stock options offered by foreign parent companies to employees of its Indian subsidiaries are also taxed under the Income Tax Act. Several companies and chambers of commerce have been pleading with the government that employee stock options be taxed as a capital gain only at the time of sale of stock options. The following are key issues in taxation of stock options:
In the U.K. and the U.S.A. and several other industrialized countries there are a variety of legislative measures which provide tax concessions to corporates and trusts establishing employee stock options .In India, such tax concessions have not been introduced yet.
If stock options are given at a concessional rate how should the difference between such rate (also called acceptance price or exercise price) and the market value be treated for tax purposes?
Stock options are several cases part of a motivational package. It could be, in some cases in lieu of a part of salary or incentive for outstanding performance. But they are not income in the hands of the employees concerned. Therefore the question is whether they should be taxed at the time they are granted or vested or at the time the employees actually convert those stock options into cash by disposing off their stock/shares. In the budget for 2000-2001. The Finance Minister of India proposed to tax them at the time they are offered to the employees because it is difficult to keep track of movement of shares between/among employees.
In April 2000 one of the companies appealed to the income tax authorities that the stock options should not be taxed upon grant because they are vested only after the lock in period is over. Therefore, there is merit, if at all, in taxing stock options after they are vested or preferably after they are encashed.
QUESTIONS
Q1. Is bonus a deferred wage? Comment on the Statement.
Q2. What are the advantages and disadvantages of profit-sharing schemes?
Q3. Discuss whether and why stock options are becoming popular? What are their advantages and disadvantages?
Q4. How stock options are currently treated for tax purposes and how should they be treated?
Q5. What is the difference between stock options and profit sharing?
Q6. What is the difference between employee sharing and performance linked stock options'?
