Stock Option Programs — Employee Participation in Conversion

Silicon Valley has been the pioneer in stock option programs for many decades. Allowing employees to share in the economic success of a company is one of the recipes for success for a very positively developing company. In Germany, too, this form of incentivizing employees, and not just board members and managing directors, has been making its mark on the corporate landscape for more than 25 years. The aim is not just to reward a broader number of employees, but to give them a long-term share in the growth of the corporate value they have helped to create.

Participation programs are designed to enable employees to feel like co-entrepreneurs and to reduce the principal-agent conflict that otherwise often exists. Over the years, it has been shown that companies that set up long-term employee participation programs are less likely to face conflicts between management and employees and that employee turnover is lower in such companies.

How did it start in Germany?

SAP AG made a start in 1986 with the launch of a convertible bond model that enabled all employees to participate in the rapid growth of SAP's enterprise value. At that time, it was not yet possible to issue naked options to employees, as was the case in the USA, which is why the detour via a convertible bond was chosen.

It was not until the reform of stock corporation law in 1996, which also made the small stock corporation acceptable for venture capital-financed, often technology-based companies, that the Employee Stock Ownership Plan (ESOP) idea from American Silicon Valley was made more widely public in Germany. Legally, the framework conditions were laid down in Sections 192 and 193 of the German Stock Corporation Act (AktG), although the legislator obviously did not properly understand the framework conditions used in the USA and implemented them only incompletely. Thus, a two-year vesting period was provided for, instead of the three- to four-year vesting period customary in U.S. companies. The criterion of setting a performance target was also introduced, which made the usability of German stock options unattractive for non-German and in particular U.S. employees of German companies. As a result, they were no longer eligible for the same tax benefits as comparable U.S. employers.

Various tax models

On the tax side, two models competed in Germany in the late 1990s. The first is the final taxation model still in use today, under which the employee must pay tax at the time of exercising his options on the difference between the purchase price he is required to pay (strike price) and the fair market value of the shares acquired at the time the option is exercised. On the other hand, the model of initial taxation agreed upon by the author with the Bavarian Company Administration in the 1990s, the so-called "Munich Model".