Four Ideas to Make Your ESPP More Equitable

Last week, I explained how an ESPP that treats all employees equally might not truly be equitable for all employees. Today I offer some thoughts on how to help lower-paid employees participate in your ESPP so that everyone can benefit from the ESPP on a more equitable basis.

Check out my video on this topic as well.

Know Your Employees

The first step is to examine your employee population to assess how much of a concern this is for your company. I suggest starting with two analyses for which you should have data somewhat readily available: 

• ESPP Participation by Wage Level: Do lower-paid employees participate in your ESPP at a lower rate than higher-paid employees? Start by looking at employees below the median as compared to those above the median, then drill down from there. Significant differences in participation rates may indicate that lower-paid employees are experiencing barriers that prevent them from participating.
• ESPP Contribution Rates by Wage Level: Next, look at contribution percentages using the same wage groupings you used for the first analysis. Here again, significant differences in contribution rates may indicate barriers that prevent lower-paid employees from contributing at the same percentage as their higher-paid peers.

In addition to those analyses, it may also be helpful to look at employee participation and contributions by gender, ethnicity, and region. If you find that participation and contribution levels are low overall, even among higher-paid employees, that may indicate flaws in either the design of the plan or how the plan is communicated to employees that will also need to be addressed.

Here are four ideas to consider that could make your ESPP more equitable:

1. Expand the Definition of “Compensation”

As I noted last week, many ESPPs prohibit contributions from forms of compensation that are common to hourly workers, such as overtime and shift differentials/premiums. Likewise, prohibiting contributions of commission-based pay can also unfairly affect some workers.

Consider expanding the definition of “compensation” in your plan so that your ESPP doesn’t unfairly favor salaried employees.

2. Allow Fractional Share Purchases

For companies with a high stock price, one obstacle preventing lower-paid employees from participating is that they may not be able to contribute enough to buy even a single share of stock. Your stock price may not need to be as high as you might expect for this to be a concern.

For example, assume an employee who earns $20,000 a year contributes 1% of her pay to the ESPP. In a typical ESPP with a 15% discount and purchase dates every six months, she will not be able to purchase a full share if the FMV the price is based on is $118 or higher. 

Thus, in companies with high stock prices, lower paid employees may be forced to contribute a higher percentage of their pay to participate in the ESPP. Allowing fractional shares purchases enables these employee to enroll in the plan at a minimum contribution level. in some cases, this may be all they can afford to contribute. It also can help employees who don't have experience with stock ownership feel more comfortable about participating in the plan.

To assess whether this is a concern for you, calculate how many shares the lowest-paid employees in your company can purchase if they are enrolled at the minimum contribution rate. Allowing employees to purchase fractional shares can be the difference between these employees participating or not.

Beware: One trap for the unwary here is that, while most brokers can support fractional share purchases in an ESPP, some cannot support a fractional share that is not anchored by a whole share. E.g., a purchase of 1.5 shares is supported, but a purchase of .5 shares is not. Discuss this with your brokers before deciding to allow fractional share purchases.

3. Switch to a Nonqualified ESPP

I’ve previously written about the advantages of nonqualified ESPPs (“ Solving the Challenges of a Global ESPP” in the NASPP Blog and “ Top Ten List: Reasons to Consider a Nonqualified ESPP” in The NASPP Advisor). When freed from the constraints of Section 423, companies can offer additional assistance or incentives to help lower-paid employees participate. Here are some ideas:

• Offer a greater discount (or better yet, a contribution match) for lower-paid employees.
• Offer a match with a cap on the maximum contributions per person that are eligible for it (similar to how a match in a 401(k) plan typically works).
• Provide lower-paid employees with an additional subsidy or contribution to boost their participation.

As noted in the blog entry “ Solving the Challenges of a Global ESPP,” SAP offers a €20 subsidy to all nonexecutives who participate in their ESPP. For employees in wealthier countries, this subsidy feels nominal. But the subsidy can double the monthly contribution of employees in more economically disadvantaged economies. It is the difference between them being able to buy a share of stock and not being able to participate.

4. Go Cashless

Perhaps the surest way to offer a more equitable ESPP is to offer employees a way to finance purchases under the plan that doesn’t require out-of-pocket contributions (see my video “ Should You Consider a Cashless ESPP?”). With a cashless ESPP, the purchase of stock in the plan is paid for through a sale of the shares (in much the same manner that executives pay for their option exercises and cover the taxes on their full value awards).

Cashless participation can be offered in either a qualified or nonqualified ESPP. For qualified ESPPs, it must be offered via an open market sale and results in a disqualifying disposition of the shares that are sold. In a nonqualified ESPP, cashless participation can be accomplished either through an open market sale or a net exercise. In either case, just enough shares are sold to cover the cost of the purchase and employees receive the unsold shares.

By allowing employees to use the built-in appreciation in their stock to finance their purchase, rather than requiring payroll contributions, employees are not put in the position of having to choose between participating in the ESPP and, say, saving for retirement, paying down debt, or simply covering their day-to-day living expenses. It can truly level the playing field and enable all employees to participate to the fullest extent possible.

There is a fourth illustration in the series I referenced last week:

In this picture, the systemic barriers and inequities have been removed so that both boys receive an equal share of apples. By reducing out-of-pocket costs for employees, cashless participation has the potential to achieve this state for your ESPP.