ESPPs in a Down Market Pose Special Challenges

When stock prices fall significantly, employee stock purchase plans (ESPPs) can run into difficult, if avoidable, problems. Most plans allow employees to buy stock at a discount from the lower of the share price at the beginning or end of the offering period. If the share price drops a lot over that period, employees may be able to buy a very large number of shares with the money they have been putting aside. Unfortunately, the limit on the amount any one participant can buy in any one year under a plan that is tax-qualified under Internal Revenue Code Section 423 is based on the share price at the beginning of the offering period. If shares are trading for $50 at that time, the limit would be 500 shares (500 x $50 = $25,000, the ESPP annual limit). When share prices fall dramatically during an offering period, companies can risk depleting their shareholder-approved pool of shares much earlier than intended. If this happens, money has to be refunded to employees and they have earned no interest over that period. In some case, plan rules may say that if shares are oversubscribed, no shares will be made available.

Writing in the NCEO's new issue brief Equity Compensation in a Down Market, NCEO board member Dan Walter of Performensation Consulting says that careful plan design and employee communication can avoid these problems. The issue brief is available for $15 to NCEO members and $25 to non-members, plus shipping.