Stock option plans

In the 1990s, large public-traded multinational companies (MNCs) have been obsessed with creating shareholder value. Stock options have emerged as one of the best ways to align employee compensation with shareholder value senior executives will only gain if the shareholders are also rewarded.

However, MNCs have learned that all too often creating shareholder value remains a preoccupation of the top management alone. Without a stake in the company, middle managers are disconnected from this process and many opportunities to increase profits and rates of return do not get pursued or evaluated adequately. There-fore, stock options have been extended to encompass all employees and not just the senior management.

For the high-technology industry, stock options have been an indispensable part of the compensation package in attracting and retaining engineers. As a result, many millionaires and even billionaires have been created. Without stock options, a high-technology company can be at a competitive disadvantage.

When MNCs started entering China they realised that, as with most developing countries, there was a limited supply of qualified staff. In order to attract and retain local talent, MNCs pay higher salaries than state-owned enterprises and also now offer incentives such as meals and transportation. Stock options are also being used by MNCs in an effort to reduce local staff turnover and maintain an already educated and trained workforce.

When new ideas are introduced into a market, they tend to adapt to embrace the local culture. This has been particularly evident in the case of stock options in China. Traditionally they are granted to employees at an agreed price and vested over time, whereupon the employee can exercise his/her right to purchase the underlying stock. However in China, due to the lack of regulatory guidance, stock options have evolved into ‘pseudo' stock options.

Stock option plans exist in China in a variety of forms but they are likely to be cashless plans and rarely include the more traditional models that are found overseas. There are some phantom plans that do not require the employee to actually invest capital. Under this type of plan the employees do not have the ability to own shares after the agreed period, but rather they are paid the difference between the stock price offered at the grant date and the date of exercise of the option. Some plans may even have a minimum gain guaranteed.

The ‘stock option' concept of compensating employees, particular the local Chinese nationals, is relatively new in China. A tax circular was issued by the State Administration of Taxation in 1998, regarding the tax implications of stock options. However associated foreign exchange control, legal implications, regulatory and disclosure requirements are yet to be addressed specifically by any relevant Chinese legislation.

Many questions remain unanswered, such as what rules apply to foreign stock holdings and what are the local qualifying criteria, disclosure and reporting requirements. Various regulations in China relating to foreign exchange have made the exercising of stock options technically infeasible.

According to existing foreign exchange rules and regulations, Chinese nationals not holding foreign currency may apply to the State Administration of Foreign Exchange for the remittances of foreign exchange out of China. However, in practice it does not appear to include remittances for payment of foreign listed shares.

If Chinese nationals do have foreign currency, they can hold the foreign currency, open a foreign exchange account with a bank or sell it to one of the designated foreign exchange banks. However these funds may not be remitted overseas without approval from the relevant authorities and if an individual wishes to sell the foreign currency, it must do so at one of the designated foreign exchange banks. Accordingly, if a Chinese national has no foreign currency outside China, it may be impossible to exercise the stock options unless the company allows the payment to be made in yuan.

Fierce competition
To circumvent the foreign exchange control limitations, phantom plan and cashless exercise plans have sprung to life. With the foreign currency issue dealt with and a number of MNCs now offering some kind of stock plan.

It is unclear whether they will be effective in retaining the best and brightest staff. In some instances staff regard them simply as part of a typical overall compensation package. Perhaps they only serve to retain the less capable, especially if the plans are available to every-one and have features such as short vesting periods, mandatory exercises and sell upon vesting or guarantee gains.

Even with the implementation of stock option plans there are no guarantees that the pick of the crop will be motivated or enticed to stay. Competition is fierce for experienced staff. These plans certainly benefit employees but it is debatable whether they achieved the desired objective to retain the best people within an organisation.

Written by Billy Hsieh, tax partner, and Ala Wu, senior tax manager, Pricewaterhouse Coopers in Shanghai. The above information is not intended to be comprehensive or find Professional advice is recommended befog entering into any planning arrangements.