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Employee Share Schemes Bill

18th January 2002

Employee Share Schemes Bill

Mr. Jonathan Djanogly (Huntingdon): Like my hon. Friends who have spoken, I broadly support the Bill's intentions. My hon. Friend the Member for Aylesbury (Mr. Lidington) analysed the proposals carefully, and I agreed with what he said. I shall therefore try to put the Bill's aims into the wider context of share incentivisation rather than pursuing my hon. Friend's remarks.

The Bill tweaks existing legislation, rather than requiring us to take a good look at existing incentivisation law. It merely skims the surface: while it is not harmful in any way, it is not adequate. We need to look more closely at the underlying share incentivisation legislation, and at its current limitations.

Many of the issues are very technical, but we should realise that the underlying assumptions are not. Giving employees shares in their companies is a desirable objective. It is good for employees to have an increasing say in the running of their companies, and for them to see a direct link between their own increases in productivity and the companies' success-a link which, as was noted by the hon. Member for Kingston and Surbiton (Mr. Davey), breaks down the "them and us" culture that has plagued our business sector in past years.

The increased productivity of workers, and even the increased profitability of companies, may not increase the value of shares; but that is simply the reality of the market mechanism. Employees should recognise that the value of their shares can be affected by outside events: the impact of the disastrous events of 11 September on the tourism industry is a good example. Such a recognition is useful in bringing together management and employees in a better realisation of the overall market position of their companies.

Having said that, I must add that the hon. Member for Edinburgh, North and Leith (Mr. Lazarowicz) assumes that the widening of share ownership is best achieved by a company's issuing shares to employees rather than granting share options. That may be right in certain circumstances, but not in others. It depends on the type of incentivisation required, the level of the employees, and the expectations relating to comparable incentivisation schemes in similar sectors. In high-tech companies, for instance, there will almost invariably be a high use of share options, because that is what employees in such industries will expect. Problems would arise if they were told that they should have something else.

Members have referred to what should be deemed an acceptable time for shares to be held before tax advantages are gained. That, I think, will depend on the circumstances. In certain industries a large investment will be made in a company, and employees will be expected to work at least 20 hours a day over a short period. Their vision of when they will produce their product, and of the benefits that will result in their pay packets or incentivisation schemes, must be moulded accordingly. The key to understanding incentivisation is realising that there is no such thing as "one size fits all"; the situation can be much more complicated.

Share options are often more popular with employees who, with relatively limited resources, find the gearing effect relatively attractive. Having exercised their options most people sell immediately, thus incurring no capital outlay. That greatly reduces the risks that they would otherwise incur from buying shares and then having their capital locked in an asset for five years, subject to the possibility of a fall in value.

For a company, the advantage of an immediate purchase of shares is that it will receive the additional share capital on the spot. Most companies, however, are started by entrepreneurs with perhaps one original investor-up to six, but rarely more. In practice, those individuals will certainly take up tax breaks offered by Government, but they will seldom wish to hand out cheap equity to low-paid staff from day one. Most entrepreneurs will see the low investment cost as the benefit of their having taken the risk of setting up the company and running it in the early days.

I understand from my hon. Friend the Member for Aylesbury that some 200 SIP schemes have now been approved, and that half of them were established in firms with fewer than 250 employees. It would be interesting, however, to find out how many of the schemes were set up within a year of a company's incorporation, and how many companies had issued SIP shares to people other than the founding shareholders.

Mr. Mark Field: I congratulate my hon. Friend on a thoughtful speech. As he rightly pointed out, the matter is technical, and he has succeeded in putting it in straightforward and simple terms. Does he think that certain share schemes may prevent the setting up of new companies? If a strong scheme is already in place, it may act as a powerful disincentive to would-be entrepreneurs employed in small companies, thus preventing them from breaking out on their own.

Mr. Djanogly: I thank my hon. Friend for his intervention. He is developing an argument that I was about to make. If he cares to intervene later, I shall be happy to hear what he has to say. In reality, few start-up companies would want such a scheme. The SIP concept is likely to be attractive to established smaller companies and also to larger companies that often do not want to administer large numbers of small share options.

SIPs may have an additional advantage for listed companies, especially when we consider the alternative investment market. Such companies are often larger-although by no means always. The Association of British Insurers has published guidelines on the issue of share options. The guidelines are many and complicated but, put simply, companies cannot hold more than 10 per cent. of their issued share capital subject to option. That means that companies have a limited number of options to issue. In general, the smaller the company, the less its headroom as regards the number of options.

Companies may use SIPs to incentivise lower-paid employees, rather than use up their precious packages of share options. They may want to retain those options to incentivise higher-paid employees, and in practice they often do so. However, that does not necessarily mean that the company is doing the right thing. While SIPs may to some degree increase share ownership, because they offer companies a further route through the maze of tax laws and other regulations and guidelines, none the less they are not necessarily the most appropriate form of incentivisation, from the perspective of either the company or the employee.

Profit-related pay has been mentioned. Bonuses are an important part of the armoury of incentivisation, but it is not always appropriate to hand out equity. I fully support that practice, but in certain circumstances it may be more appropriate to use bonuses. I am sure that all hon. Members appreciate that workers in many industries, especially the low paid, would prefer cash bonuses rather than the choice of receiving shares. In certain circumstances, that may be appropriate. I still fail to see why the Government abolished the PRP scheme because-

The Paymaster General (Dawn Primarolo): I am listening carefully to the hon. Gentleman's speech, but I must correct him on one point. It was the Conservative Government who abolished profit-related pay. PRP was phased out over a number of years, after the election of the Labour Government in 1997; but it was actually abolished by the Conservatives because of the huge problems in the scheme-not least its cost, which rose to £1.5 billion.

Mr. Djanogly: The scheme was phased out, and that was contentious at the time. One important arm in the ability of companies to decide how to remunerate their employees was taken away. Cost may indeed have been highly relevant to Her Majesty's Treasury at the time, but that does not mean that the principle was wrong and that the Government should not be encouraged to reconsider such measures as a means of incentivisation.

The measure will open up the SIP regime to a wider base, such as trust-based companies. That is certainly to be commended. However, the measure will not improve the underlying weaknesses of the SIP regime. As I have tried to argue, the regime is unlikely to help starting-up companies, or indeed middle-ranking companies.

The briefing notes for the Bill state that many firms, especially small family-owned ones, are eventually handed over to their employees, and that the changes to corporation tax under the Bill will make it possible for more businesses to be transferred into employee ownership. That may be true in certain cases, especially for extremely small companies, but normally the company purchases are carried out by a small number of managers rather than the staff as a whole-so-called management buy-outs. In such circumstances, the £7,500-worth of shares that have the benefit of SIP status are likely to be negligible in the context of the transaction as a whole.

I very much doubt whether the impact of the Bill will enable employee buy-outs-one of its intended effects-other than for tiny companies or, occasionally, large transfers where enormous administrative problems would have to be overcome.

Mr. Edward Davey: I do not understand the point that the hon. Gentleman is making. The management buy-outs that he describes happen anyway. The point of giving tax relief is to encourage behaviour that would not otherwise happen. My understanding of the Government SIP scheme and the Bill is that they would encourage something that would not happen otherwise.

Mr. Djanogly: The hon. Gentleman makes an interesting point. The rationale for the Bill can be considered at various levels. On the one hand, it is a straightforward attempt to encourage employees to become interested in their company, but as we can see from the briefing notes the measure would also provide that SIPs could be used as a another mechanism to promote activities such as employee buy-outs. I am simply saying that that is unlikely to be the case, and that the real benefits of the Bill are likely to be more modest than several hon. Members have implied. Of course, that does not mean that the Bill is worthless.

Mr. Gareth R. Thomas (Harrow, West): The hon. Gentleman is making a distinctive contribution, focusing on many of the technical issues that form a background to the Bill. He spoke about the rationale for introducing the Bill and said that there were several different levels. Has he been influenced by the most basic form of rationale for legislation: the fact that his constituents want the Bill? Would he join me and other Members of Parliament who have been lobbied by employees of the John Lewis organisation in congratulating them on the effectiveness of their lobbying operation?

Mr. Djanogly: I certainly would congratulate John Lewis on that lobbying operation. John Lewis does not have a base in my constituency, but it does close by. As I said, the larger organisations such as John Lewis could enjoy real benefits from legislation such as the Bill because it would give them another way of incentivising their employees. To that extent, I welcome the principle of the Bill.

However, it is important to appreciate that-probably because of the limitations of the underlying legislation-the Government wisely decided not to abolish previous share incentivisation plans, such as the save-as-you-earn share option scheme and the company share option plans. Although they were by no means perfect, they at least-together with the Government's new enterprise management incentive scheme-make available a wider package for tax-advantageous share ownership and incentivisation. However, there remain significant problems with all those schemes, which we need to get right. There is still much to do. The business of a company may not qualify to be included. The company may not be independent-I appreciate that, in a limited context, the Bill identifies that as an issue to be dealt with for certain companies-or its assets may be too great. In practice, there will be many occasions on which, and many different reasons why, a company cannot tick all the boxes that it needs to tick to set up a particular incentivisation plan.

In such situations, the company will need to fall back on the so-called unapproved issue of shares or unapproved grant of options-in other words, schemes that do not have tax benefits. In such circumstances, once the top layer of the schemes is removed, the picture changes somewhat to reveal a system that is extremely complicated and often unfair to company and employees, and in which the tax payable has been substantially increased by the Labour Government.

If the Bill is truly to improve share ownership and encourage the setting up of new companies and the incentivisation of employees who wish to purchase their own company, I would suggest that three issues in particular need to be covered. The first concerns listed companies whose shares have fallen substantially. Many, if not all of their share options will be "under water"-the exercise price of the shares will be greater than the price at which they are currently quoted. Many such companies, which are particularly predominant in the technology sector, will have issued share options up to the maximum permitted level of 10 per cent. of their issued share capital. As a result, many dozens of companies are negatively incentivised. I would suggest that, in such circumstances, it be made easier for companies to terminate existing options and re-issue at the lower current market price.

Mr. Davey: The hon. Gentleman has just put forward an interesting idea. What does he think the impact of his proposal would be on the nature of risk-taking associated with employee share ownership?

Mr. Djanogly: The nature of risk-taking is not relevant because the individual can decide not to exercise those options, so there is no risk for the employee; there is simply no incentivisation in so far as he will not exercise those options. If one wished to incentivise employees who are in that position, one would need to cancel the existing options and re-issue new ones. If a company has had a very high share price and the market collapses, as the technology market did, employees may well have share options at a strike price that is so far ahead of the market price that they are negatively incentivised rather than incentivised by having those share options.

Mr. Davey: Will the hon. Gentleman give way?

Mr. Djanogly: I feel that that issue needs to be addressed, but I shall move on if the hon. Gentleman does not mind.

I have a second suggestion for improving the Bill. Since April 1999, national insurance has been charged to companies on gains arising from the exercise of unapproved options. That has been nothing more than a staff tax. In practice, companies have been amending their documentation to say that they can get the employees to pay the extra tax on their behalf, but it is conceptually wrong that a company has to pay national insurance on the open-ended growth of the value of its own shares. Finally, where a company agrees to deliver shares and those shares are forfeitable due to performance conditions-resembling an SIP but without the tax breaks-the gain becomes taxed on the value of those shares at the point when they become non-forfeitable. As with the options, the gain would be unascertainable on grant, but worse than with options, the company could not recover national insurance from its employees. Clearly, the position should be aligned with share options or, better still, national insurance on the growth in value should be abolished. The reference to the United States by the hon. Member for Edmonton (Mr. Love) reminds me that employees there have the opportunity to choose whether to pay up front or later, and we could do much by adopting the same position. I conclude by repeating that the measures that we are debating today will do no bad at all and some good, but they will tinker at the edges of the issue and fail to get to the heart of the problem.

12.5 pm

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