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The Myths of ESPP

October 02, 2016

Employee Stock Purchase Plans (ESPPs) have had a long history in equity compensation. Over the years we've seen many changes in plan design trends - some driven by economic factors, some driven by changes to accounting regulations, and others "just because." Through it all, it seems like some of the beliefs around ESPPs have taken on the status of an urban legend (you know, those stories that float around where nobody quite knows if they are true or not). Even now we hear a lot of buzz about ESPP, and not all of it rings true. In today's blog, I'm going to take on three of the ESPP myths that have achieved urban legend status.

I recently caught up with Emily Cervino of Fidelity (many of you may know Emily as a passionate supporter of ESPPs) to talk about some of these myths. My full interview with her (including 2 additional myths not discussed in today's blog) was captured in the most recent episode of our Equity Expert podcast series—be sure to check it out!

Myth #1—An ESPP is Like an ATM Machine

I often hear people describe ESPPs just like the caption above—they are an ATM machine. As soon as employees purchase the shares, they will cash them out (via sale). It's not an investment tool—it's a short term savings plan, and it's too much administrative headache and accounting expense to take that on. And so on, and so on. So what's the truth? The NASPP's 2014 Stock Plan Administration Survey ("2014 Survey"), co-sponsored by Deloitte, shows dramatically different behaviors when it comes to the length of time ESPP participants hold their shares. Only 11% of responding companies report that the majority of participants sell shares immediately, and only 8% of respondents report that participants sell, on average, within the first 6 months after purchase. That means 81% of respondents find that, on average, participants hold their ESPP shares at least 6 months, and 67% of respondents find that, on average, participants are actually holding a year or more. This is similar to data from the NASPP/Deloitte 2011 Stock Plan Administration Survey, so this is not a new trend.

Myth #2 - Offering An ESPP is Too Expensive From an Accounting Perspective

Accounting standard FAS 123R (now referred to as ASC 718) brought an end to an era of widespread non-compensatory ESPP plans. Today, most ESPP plans are considered compensatory for accounting purposes (meaning the company must now record an expense for them) unless they meet specific criteria (a safe harbor plan with a maximum 5% discount and no look back). According to the 2014 Survey, 66% of respondents with a Section 423 plan offer some type of look back for purposes of determining the purchase price. And, the majority of companies offer more than a 5% discount, so the majority of ESPPs are considered compensatory. Although most ESPP plans are now compensatory, they are still less expensive than other forms of equity compensation, and when the value to the participant for that expense is considered, many experts agree that they are still a good or great bang for the buck.

With expense related to ESPPs commonplace, companies have found ways to curb the expense. Some companies have implemented share limits as a plan feature, meaning that the participant can only purchase up to a maximum number of shares over a given period (offering, year, or some other period). This seems to be more favorable than a limit on contributions—because if your stock is volatile and the price goes up, the number of shares that a participant can purchase could be greatly limited. Additionally, since expense is tied to the shares and not the contributions, it seems more predictable to establish a limit on shares purchased. Lastly, the IRS already has a statutory dollar limit in place - it's not on contributions per se, but rather on the value of shares purchased—Section 423 plan participants can't purchase more than $25,000 worth of stock in a calendar year.  According to the 2014 Survey (here I am citing Section 423 plan data only; see the survey for non-qualified plan data), 56% of companies have a limit on shares purchased (19% have no limit other than statutory limits; only 16% limit contributions based on a percentage of compensation and 26% have a set dollar amount limit).

Myth #3 - Communication Does Not Impact Participation in the ESPP

I've heard many variations of this myth: "No matter what we do, the participation rate is what it is—and it's not much." Or, "ESPP is such a simple concept, we don't really need to communicate—it's a plan that runs on autopilot." Both of these statements are proving incorrect, and we are starting to see data to support a different notion—there is a correlation between communication and ESPP participation. At the NASPP's recent 22nd Annual Conference in Las Vegas, two companies detailed recent efforts to makeover their communication programs in the session Extreme Makeover:ESPP Edition. One of those companies, Baker Hughes, made no plan design changes and focused solely on improving ESPP communications. The results of those efforts increased participation in the ESPP by 18% in the US and 35% internationally. The other company, Hologic, made a series of plan design changes (moved from a safe harbor plan to a 15% discount and 6 months lookback) and significantly expanded their educational program. Participation in the plan increased from 14% to 31% in just six weeks. Additional educational efforts (no further design changes) raised participation to 51%. While these are only two companies, they are two success stories, and communication played a big role. There are many ways to educate employees these days, and companies are getting more creative—incorporating white board videos, mobile friendly content and language translation into their communication strategy. There were some great sessions on communication strategies and approaches at the Annual Conference that addressed everything from the latest tools to communicating to the short attention span. You may want to check out the audio or materials if you missed these sessions.

I've only scratched the surface of addressing some of the ESPP myths. If your company is considering an ESPP, looking to increase participation in the ESPP, contemplating a plan design change or simply curious, check out some of the following resources to get started:

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    By Jennifer Namazi

    Content Director