Equity Incentive Plans and Employee Share Option Scheme (ESOS): A Guide for Companies in Malaysia

By Aaron Liew and Jasmine Wee

In Malaysia’s fiercely competitive business landscape, the ability to attract and retain top talent is more crucial than ever for corporate growth and sustainability. Companies are increasingly recognizing that the key to employee retention lies not just in traditional rewards but in offering more substantial stakes in the company’s success. Equity Incentive Plans (EIPs) are becoming pivotal in this strategy, providing a robust mechanism to acknowledge and reward employees’ hard work and dedication.

Equity Incentive Plans not only offer varied benefits such as bonuses, salary increments, and promotions but also include more direct forms of participation in company growth, like Stock Options and Employee Share Option Schemes (ESOS). As these incentive structures become more sophisticated and widely recognized for their effectiveness, they play an essential role in motivating employees and fostering a deep sense of belonging and loyalty. This article discusses the various types of Equity Incentive Plans, with a focus on the increasingly popular ESOS, exploring their mechanisms and strategic benefits in enhancing employee retention and company development.

Legal and Regulatory Framework

In Malaysia, the governance and regulation of Equity Incentive Plans, including Employee Share Option Schemes (ESOS), are overseen by one of the key regulatory bodies, Bursa Malaysia. This ensures that all equity incentive offerings align with financial regulations and corporate governance standards.

Bursa Malaysia plays a pivotal role in regulating ESOS under the framework of the Capital Markets and Services Act 2007 (CMSA) along with specific Guidelines on Employee Share Option Schemes. These regulations are designed to ensure transparency and fairness in the administration of equity incentives, safeguarding both corporate interests and employee rights.

Additionally, under Section 129 of the Companies Act 2016, stringent requirements are set for the management of share options. Companies are mandated to maintain a detailed register of all options granted to eligible employees. This register must include critical information such as the grant date, the number and details of shares offered, the terms for exercising the options, and the consideration involved, if any. The company must update this register within fourteen days of granting any options to ensure compliance and maintain transparency.

Failure to adhere to these regulatory requirements, especially those stipulated in Section 129, can lead to significant legal consequences, including penalties under the Companies Act 2016. This underscores the importance of rigorous compliance and accurate record-keeping in the implementation and management of Equity Incentive Plans.

This rigorous regulatory framework not only ensures the proper functioning of equity-based compensation schemes but also reinforces the trust and confidence of employees participating in such plans, ultimately enhancing their effectiveness as tools for retention and motivation.

Types of Equity Incentive Plans

Equity Incentive Plans offer a versatile range of options for Malaysian companies aiming to enhance employee engagement and retention while driving organisational growth. These plans are designed to align the interests of employees with the long-term goals of the company, offering them a stake in the company’s success. Among the various types available, each serves a distinct purpose and offers different benefits. Below, we discuss the popular Employee Share Option Schemes (ESOS) in detail and briefly cover other types of Equity Incentive Plans.

Employee Share Option Scheme (ESOS)

The Employee Share Option Scheme (ESOS) is becoming increasingly popular in today’s competitive business environment, offering selected employees the opportunity to purchase company shares at a price usually below the current market value. This scheme is suitable for companies of any size and serves as a direct way for employees to engage in the growth and profit-sharing of their company.

Under an ESOS, employees are granted options that provide them with a contractual right to purchase shares at a predetermined price within a specific period. The structure and quantity of these options are usually determined by the company’s board of directors or a compensation committee, ensuring that the allocation aligns with broader corporate objectives. These options typically include a vesting period, requiring employees to remain with the company for a certain duration before they can exercise their purchasing rights. This vesting period is strategically designed to enhance employee retention, often staggered over several years to incentivize long-term commitment.

Implementation of ESOS

Implementing an ESOS can occur at any stage of an employee’s career and can be introduced as part of a new hire’s employment package or offered to existing employees as part of their career development and retention strategy. It is critical that the terms of the ESOS are clear and unambiguous to ensure all participants understand their rights and obligations.

The process begins with the grant date, often referred to as the ‘offer date’ or ‘award date,’ which marks the start of the vesting period. Employees must then meet specific criteria set out in the plan, such as duration of service or performance targets before they can exercise their options. Once these conditions are satisfied, employees enter an exercising period during which they can purchase the shares. If they do not exercise their options within this timeframe, the options expire, making it crucial that employees are aware of these timelines. Key terms include:

• Grant Date: Also known as the ‘offer date’ or ‘award date,’ this is the official date when the options are made available to employees, marking the beginning of the vesting period. This date is crucial as it sets the timeline for all future actions related to the options.
• Vesting Period: The vesting period defines the time frame employees must wait before they are eligible to exercise their options. This period can be determined by various factors, including:
• Tenure-Based Vesting: Options vest based on the duration of the employee’s service to the company.
• Performance-Based Vesting: Vesting occurs upon achieving specific performance targets.
• Hybrid Vesting: A combination of tenure and performance criteria. This method specifies a timeline that employees must meet to exercise their options, aligning their contributions directly with company goals.
• Exercising Options and Period: After the vesting conditions are met, employees have the right to purchase shares at the predetermined price.
• Exercise Period: This is a set period during which vested options can be exercised. It is crucial for employees to act within this timeframe; otherwise, the options may expire if not utilised.

Consider the case of Jenny, who joined Company A in early 2021. Upon completing her probationary period, she was offered ESOS options to buy shares at RM0.20 each, starting after two years of employment. By 2023, having met the vesting criteria, Jenny can exercise her right to purchase these shares. However, if she does not act by July 2025, her options will lapse, underscoring the importance of timing in such schemes.

Strategic Benefits of ESOS

Implementing an Employee Share Option Scheme (ESOS) offers substantial benefits to both the company and its employees, driving mutual growth and success:

• Profit Sharing and Success Participation: ESOS provides employees with a direct stake in the company’s profitability. By granting options to purchase shares at a predetermined price, employees stand to gain financially as the company’s stock value increases. This alignment helps cultivate a workforce that is deeply invested in the company’s success, enhancing their motivation to contribute effectively.
• Enhanced Retention and Recruitment: One of the primary benefits of ESOS is its power to attract and retain top talent. Employees who see a clear path to sharing in the company’s growth are more likely to stay committed over the long term. This scheme not only helps in retaining valuable employees but also makes the company more attractive to potential high-calibre recruits. By offering a share in future profits, ESOS acts as a compelling incentive for employees who value financial growth and company loyalty.
• Motivation and Employee Engagement: ESOS incentivizes employees to contribute to the company’s objectives since their financial gain is tied directly to the company’s performance. As employees see their efforts translate into tangible rewards, their ongoing commitment to the company’s goals strengthens, driving a more engaged and productive workforce.
• Financial Liquidity and Control: From a corporate finance perspective, ESOS can enhance cash flow. As employees exercise their options, the company receives capital in exchange for shares, boosting liquidity without compromising control. Unlike external financing methods, ESOS allows the company to raise funds while retaining ownership and decision-making powers, ensuring that control remains with current owners and stakeholders.
• Long-term Commitment to Company Goals: The structure of ESOS, requiring a vesting period before the options can be exercised, ensures that benefits accrue to employees who demonstrate long-term commitment to the company. This setup aligns employee interests with corporate goals, as the rewards are realised only when the company achieves specific milestones.

Implementing ESOS effectively creates a partnership between the company and its employees, where both parties benefit from the company’s success. This symbiotic relationship fosters a culture of ownership and participation, crucial for sustaining growth and innovation in competitive markets.

Stock Options

Stock options are a form of equity-based compensation companies use to incentivize their employees. It grants the employees the right to purchase a specific number of company shares at a predetermined price within a specified period. Stock options allow employees to benefit from any increase in the company’s stock price over time. This arrangement allows employees to potentially profit from increases in the company’s stock price over time, aligning their efforts with the company’s financial success.

However, stock options do not grant the individual employee such a right to become a shareholder immediately. The individual employee will only become a shareholder when the vesting period has passed, permitting them to exercise their rights as agreed upon under the scheme. Once the vesting period is completed, employees can exercise their options to buy shares, thereby becoming shareholders with voting rights and eligibility for dividends. This phased approach ensures that the benefits of stock options are tied closely to an employee’s ongoing contribution to the company, reinforcing their commitment to the company’s long-term success.

Restricted Stock Units (RSUs)

Restricted Stock Units (RSUs) can be used by public listed companies to benefit their employees as part of their overall compensation package. When companies grant RSUs to employees, they are essentially promising to give the employee a certain number of company shares at a future date. Employees earn ownership of the shares over time, typically based on the length of their employment or meeting certain performance goals. During a vesting period, RSUs are considered restricted as the employee cannot sell or transfer them. However, they may receive dividends or have voting rights depending on company policy. If an employee leaves the company before the vesting period is delivered, equity awarded under the RSUs will cease to have any effect.

Unlike stock options, RSUs grant the company’s employees guaranteed shares after employees reach certain conditions, whereas stock options give employees the opportunity to buy shares of the company at a specified price – usually below market price.

Overall, RSUs can be a valuable component of an employee’s compensation package, offering the potential for ownership in the company and alignment of interests between employees and shareholders. However, it is essential for employees to understand the terms associated with RSUs before accepting them as part of their compensation.

Performance Share Units (PSUs)

Similar to RSUs, Performance Share Units (PSUs) are used by companies to monitor the various goals and metrics achieved by employees. Like RSUs, PSUs are granted to employees as part of their compensation package. However, instead of being based solely on time, PSUs are tied to predetermined performance metrics, such as financial targets, operational goals, or stock price targets.

The performance period during which the employee must meet or exceed the specified performance criteria can vary depending on the company’s policies but it is typically within 1 to 3 years. Performance goals or targets associated with PSUs can also vary widely depending on company objectives. They may include metrics such as revenue growth, earnings per share, total shareholder return or other key performance indicators relevant to the company’s industry and strategic objectives.

PSUs typically have both performance-based vesting criteria and time-based vesting criteria. Once performance goals are met at the end of the performance period, the PSUs may begin to vest according to the predetermined schedule. If the performance goals are not met, the PSUs may be forfeited.

While PSUs can be an effective way for companies to motivate and reward employees based on their contribution to achieving company goals, they can be more complex than traditional equity awards like RSUs due to the performance criteria involved.

Employee Stock Purchase Plans (ESPPs)

Employee Stock Purchase Plans (ESPPs) are company-run plans that allow participating employees to purchase company stock at a discounted price. ESPPs are plans automatically implemented by the employee’s contribution through salary deductions. On the purchase date, the company will utilise the employee’s accumulated funds to purchase stock in the company on behalf of the participating employees. This allows employees a convenient and affordable way to acquire company shares without having to expend additional costs for purchasing the shares.

Some ESPPs have holding requirements that require employees to hold onto the purchased shares for a certain period before they can be sold. This is intended to encourage long-term ownership and align employee interests with those of shareholders. While ESPPs can be a valuable employee benefit, they also come with risks. Employees who participate in ESPPs are subject to fluctuations in the company’s stock price, and there is no guarantee that the stock will increase in value.

Conclusion

An Equity Incentive Plan like ESOS creates a win-win situation for the company and the employees as it brings long-term benefits to the company and employees, where both the company and employees can enjoy and share success. A company may consider approaching and implementing an ESOS for the benefit of the company. Nevertheless, a company may also consider other types of Equity Incentive Plans depending on the company’s structure, goals and objectives.

Nevertheless, an Equity Incentive Plan can be challenging to implement as it can be complex depending on the scheme offered by the company. As such, companies must understand the benefits and the complexities behind the scheme before proceeding. Companies should further ensure that any implementation of such Equity Incentive Plan complies with the current laws and regulations.

If you would like to further understand the mechanism or implementation of Equity Incentive Plans or ESOS, please reach out to our legal team for consultation and guidance. Our lawyers are equipped with the necessary expertise and we are committed to assisting your company in understanding the mechanism of your preferred Equity Incentive Plans and the implementation aspects of the scheme.

By Aaron Liew and Jasmine Wee

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