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12-19-2008, 02:05 PM
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Compensation trends in India
Current trends Productivity gains (4% in 2003-04), fast growth in real wages (40% over the last 5 years), a booming but extremely competitive economy (GDP growth of 6%), simplification of tax rules and emergence of knowledge-based industries such as Information Technology & Outsourcing Services, Healthcare etc are key factors that have influenced compensation in India post liberalization. Compensation is now characterized by a Total Cost of Employment approach, a rapid movement to flexible benefits, and increasing levels of variable pay (variable pay now forms about 7% - 35% of fixed pay). Grade structures have become organization specific and salary progression is driven by market forces and individual performance. Average salary increases over 2003-04 ranged from 5% - 20%. The average increase was 11%. While most organizations benchmark compensation nationally within a select group of competitors, a few organizations are beginning to benchmark themselves internationally at senior management levels. Different compensation plans - how do they affect your financial results With the introduction of FRS 102 Share-based Payment, companies are required to recognize the expenses of employee equity compensation schemes with effect from 1 January 2005. This article highlights the major implications to the financial results of the three most common equity compensation schemes, namely share option scheme, performance shares scheme, and Share Appreciation Rights (SAR, also known as phantom share scheme). Key Characteristics The key characteristics of each scheme are as follows: Share option scheme
Share Appreciation Rights
While all three schemes require the use of fair values of the share options or shares for the recognition of the compensation expense over the vesting period, the impact on the company’s financial position and financial results is different. Impact on net assets The three schemes have a different effect on the net asset values of companies. Under FRS 102, share option scheme and performance share scheme are considered “equity-settled”. This means that in recognizing an expense for the compensation costs, a corresponding increase in shareholders’ equity is recognized. Hence, the net asset position of the company is unchanged. In contrast, obligations under SAR schemes are considered liabilities of the company, as there would be a cash settlement when the right is exercised. The recognition of the compensation cost under SAR results in a decrease in the net asset of the company. (1) Revaluation of share options/shares during life of grant With share option and performance share grants, fluctuations in the values of the share options and shares during the life of the grant do not affect the results of the company. This is because the measurement of the share option or share is determined at the date of the grant and is not subsequently revalued. In contrast, for SAR, the company is required to revalue the SAR at every reporting date until the right is settled or expires. This is because the company has to measure its liability (cash payment to employees) at the expected settlement amount. Hence, SAR schemes create more volatility to the financial results. In addition, more resources are also required to perform the revaluation at every reporting date. SAR will continue to impact earnings even after the vesting period because the liability is re-measured until the exercise date. (2) Treatment of unvested rights The compensation cost is a function of number of options or shares that are expected to vest by the vesting date and the fair value of the option or share. In estimating the number of options or shares expected to vest, only non-market based conditions, which are not based on the market performance of the shares, are considered. These non-market based conditions include the continuance of service over a period of time, and the meeting of a certain revenue target. If no employees meet the non-market based vesting condition by the vesting date, the company does not incur any expense. No performance shares would be issued for performance share schemes and no share options or SAR would vest. If share options or SAR are vested by vesting date, the financial impact of the two schemes is different. For share option schemes, if the share options are not subsequently exercised by the employees (for instance, because the options are out of the money), the company is not allowed to reverse the expenses already charged to the income statement. For SAR schemes, the liabilities are stated at the expected cash settlement. If the SAR is not subsequently exercised, the company is allowed to reverse the expenses previously charged to the income statement. Impact on Tax Regardless of the above changes, charges to an entity’s income statement relating to share option or performance share schemes, in form of capital or notional cost (such as cost of options granted), are not tax-deductible. Compensation charges that represent actual outgoings (cash outflow or actual liability) to the company may be deductible such as the buying back of its own shares, i.e. treasury shares, to satisfy the obligation to the employees. In addition, such share-based compensation costs must be directly related to the employee’s employment compensation benefits in Impact on Earnings Per Share Share option and performance share grants have a dilutive effect on EPS, as shares will be issued. For SAR schemes, shares are not issued; hence there is no dilutive effect on EPS. Moving forward Prior to the implementation of FRS 102, the design of the share compensation plan is often dependent on non-financial factors as the company is not required to recognize an expense on the equity instrument granted. However, with the implementation of FRS 102, it is critical for companies to consider and analyse the financial impact, arising from the design and structure of the scheme, at an early stage. 
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