Shareholder value in a bank is enhanced when the individuals who manage and operate the bank have an incentive to maximize profitability. In order to do this, directors must attract and retain quality and key employees. There are a number of incentive options that may be appropriate for bank employees, including an employee stock ownership plan (ESOP), an incentive stock option plan (ISOP), a stock appreciation rights plan (SAR) or a phantom stock plan, non-qualified stock option plans, and restricted stock plans.
An ESOP is an employee benefit plan that provides a company’s employees with an ownership interest in the company. It creates liquidity for the bank’s shareholders as well as establishes a benefit for the bank’s employees. The basic rules of operation are the same as other qualified retirement plans, but it differs from other plans in that the primary investment of the ESOP must be employer stock. Because participants in the plan are shareholders themselves, participants have an interest in insuring that the company’s stock performs well.
An ISOP is a qualified stock option that defers any tax consequence to when the stock is sold. ISOP’s encourage employees to remain with a company long-term and contribute to the company’s growth and development. The option must be priced no less than fair market value at the time it is granted, and the expectation is that the shares will increase in market value by the time they vest. Thus, employees can buy the stock at a discount (the fair market value at the time the option is granted) then sell at a premium, i.e. the appreciation in market value at the time of vesting. There are a number of requirements including a restriction on transferability, a 10 year period in which the employee must exercise the option, and others that, if satisfied, exclude the incentive stock options from compliance with IRC Section 409A requirements for defined compensation type plans.
SAR and Phantom Stock Plans
Alternatively, SAR plans and phantom stock plans resemble employee stock options in that the employee-holder benefits from an increase in stock price. The SAR plan entitles an employee to the appreciation in value of the company’s shares held in the employee’s account over a period of time. The employee thus receives cash based on the increase in fair market value of the company’s stock from the date the right is granted to the date it is exercised. A SAR plan does not give employees any voting or ownership rights in the company.
Non-qualified Stock Option Plan
While ISOP’s are often granted to officers and employees, non-qualified stock option plans are often concurrently granted to directors. A non-qualified stock option has the fair market value of the stock at the time of grant as the exercise price, and when the option is exercised, the director or employee will pay ordinary income tax on the difference between the grant price and the fair market value at the time the option is exercised.
Restricted Stock Plan
Finally, a restricted stock plan generally grants stock to executives in which the recipient’s rights in the stock are restricted until the shares vest. Restrictions include certain financial goals that must be met before the stock vests or a certain time of continued employment. The stock does not vest unless the conditions associated with the restrictions are met.
There are a number of incentive plans available to attract and retain employees. It is important to consider the benefits and drawbacks of each plan and determine what fits best for your bank’s needs.