This content is from: Local Insights

Employee stock ownership plans

On November 17 2008, a committee organised by the Ministry of Economy, Trade and Industry to study new employee stock ownership plans released its report. The report mainly aims to maintain and enhance the global competitiveness of Japanese companies by promoting the introduction of new employee stock ownership plans. Actually, some companies have already started to introduce such new plans (Japanese ESOPs), which are named and somewhat modeled after employee stock ownership plans in the US. However, the number of companies with new plans is still small because there are some potential legal, accounting and tax issues associated with such new plans. Therefore, in order to make new plans more prevalent, the committee studied these issues, and released a report that suggests possible solutions.

The aim of these new plans is to provide incentives for employees to work in the same company over the long-term (which used to be common in Japan before), to raise employees' sense of involvement in the management of the company and to make employees more aware of the share price of their company. To achieve this purpose, new plans establish a system whereby medium to long-term shareholding by employees is ensured, because as shareholders, employees have more incentive to increase their company's profitability.

This new set up differs from the most prevalent employee stock ownership plans in who mainly funds for purchasing shares. Under these older style plans, shares are purchased using mainly employees' funds, and employees are able to sell their shares whenever they choose. The result is that these plans do not necessarily provide incentives for employees to work for the same company on a medium to long-term basis. New plans use vehicles such as trusts and ippan shadanhojin. These vehicles are used to hold shares for medium to long periods of time before transferring them to employees (for example, under some plans employees do not receive shares until they retire from the company), which ensures medium to long-term shareholding by employees.

In many cases, these vehicles are also designed in a manner that reflects the will of the employees when the vehicle exercises its voting rights as a shareholder of the company (for example, a vehicle may have a guideline that it is bound to exercise its voting rights in accordance with the interests of employees). Such designs are thought to be effective for improving corporate governance and the quality of management of a company from a medium and long-term perspective because employees better understand the quality of officers and the problems of management.

However, under new plans, some legal, accounting and tax issues arise. One issue comes from the funding scheme, where shares are purchased by such vehicles using funds contributed by the company or funds borrowed from financial institutions. When a company funds such vehicles, it may conflict with the provisions of the Companies Act which restricts a company from acquiring its own shares. In addition, new plans may conflict with another provision of the Companies Act which prohibits a company from providing benefits to a shareholder in exchange for the exercise of a shareholder's rights. As the vehicle is a shareholder of the company, the company's funding may be seen as such a benefit. The report concludes that new plans do not violate these provisions of the Companies Act if certain conditions are met.

The report also clarifies that it is feasible for a company to transfer shares to an employee through a vehicle, and under certain conditions, this is not a violation of the labour regulations that restrict payment of wages or other compensation to currency. Furthermore, the report points out certain accounting matters that should be considered when a company is to introduce a new plan. For example, from an accounting standpoint, it is important to consider whether a vehicle under the new plan is treated as a company's subsidiary.

It is expected that more Japanese companies will design and introduce new plans based on the report so that they can maintain and enhance global competitiveness.

Akira Matsuda and Akihiro Ishikawa

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