Employee share options are often used to align the interests of employees with those of the company by tying part of the remuneration package with performance, as reflected in the share price.
In the world of finance, an option is referred to as a derivative contract, the value of which is determined by the performance of an underlying asset throughout the option period.
The purchaser of a call option on shares has a right (but not an obligation) to purchase shares in the company at a pre-determined price and date in the future. If the shares increase in value (or decrease in the case of a put option) in a manner such that the value exceeds the premium paid for the option, then the option holder is said to be “in-the-money” as he or she would have realised a profit when the option is exercised.
In financial markets, options are sold at hefty premiums and are sometimes referred to as a zero-sum game in virtue of the fact that, at face value, the gain of one of the counterparties will result in a loss to the other. Technically, however, this is not always the case due the role of market makers that hedge their positions by selling covered calls or puts.
In contrast, employee share options are not sold for premiums reflective of risk. Instead they are granted as part of the remuneration package to improve employee performance and retention, and the shares may be granted either for free, at preferential rates or at market prices, depending on how the options are structured.
Legal Basis for Employee Share Options in Malta
As of yet, there is no ad hoc legal framework for companies granting share options to employees in Malta. It appears that companies are free to create and structure their own share option plans in conformity with the respective laws that apply to them.
The basis of the legality of employee share options appears to be set out in the Investment Services Act (Exemption) Regulations. Ordinarily, companies dealing in options are required, as a minimum, to obtain an investment services licence. However, the Investment Services Act (Exemption) Regulations exempts “persons providing investment services consisting exclusively in the administration of employee-participation schemes” from the requirement to obtain such licence, paving the way for companies to offer such incentives to their employees.
It is worth noting, however, that the same Investment Services Act (Exemption) Regulations requires employers to subject the employee-participation scheme to a determination by the Malta Financial Services Authority with a view to confirm that such an exemption applies.
Other exemptions related to employee share options may also be found in the Companies Act. In particular, the provisions related to financial assistance, which forbid companies from subscribing for, holding, acquiring or dealing in shares of its parent company, and which additionally forbid companies from giving any financial assistance for the purpose of an acquisition of its own shares or those of its parent company, do not apply where such acquisition is carried out for the benefit of the company’s employees or the employees of a group company.
From a tax point of view, the Fringe Benefit Rules and the Income Tax Act establish employee share options as a fringe benefit which are taxable on the date that the option is exercised by the employee. Such tax is calculated on the basis of 42.85% of the market value of the shares after deducting any price paid for the exercise of the option.
The utilisation of employee of share options appears to be an ideal method to attract and retain talent, and to optimise employee performance. In a wider context, the use of employee share options has also been touted as a means to address the wealth gap to the extent that they provide an opportunity to fairly distribute the wealth generated by corporate profits.
However, companies should seek professional advice when considering to grant employee share options due to the risk for such incentives to have an opposite effect to the intended scope.
For instance, employee share options have often been linked to executive short-termism. As a deterrent, companies may wish to tie the exercise of such options to certain key performance indicators or other metrics or deliverables that are beneficial to the business over the long term. Employee share options may also be undesirable due to the associated administrative burden. In this instance, carefully structured share class rights, or repurchasing employee shares may be solution. Other methods of equity participation such as phantom share plans may also be considered.
There are various ways on how employees can be incentivised through equity participation. However, companies should be aware that there is no one-size-fits-all solution. Such incentive mechanisms must be tailor-made in accordance with the company’s unique culture and long term objectives.