Discuss the arguments around encouraging employees to acquire ownership 
interests in and participate in the management of the company


“I am a deep believer in Employee Share Ownership, and consider it extremely important
to recognise best practice in this area. I believe that in aligning the interests of 
employees and shareholders, everybody benefits.” Oliver Letwin, MP, Dec 2003 1

The Rt. Hon. Oliver Letwin MP, told the annual ProShare Employee Share Ownership Awards
that he certainly believes in the benefits of encouraging employee ownership. 

Employees acquiring ownership interests in Company’s has undoubtedly been on the increase in
recent years. In the UK, 95% of top listed companies now offer employee share schemes, and
over 4 million UK employees participate in them. Whether to allow employees to acquire 
ownership rights in, and therefore participate in the management of Company’s has become a 
major point of debate, which this essay will attempt to address. 

The interests of Companies, employees, investors, the state and the public will each be 
examined; as the scheme is explored from its establishment to its closure and disposal of 
shares.

Background and Definitions

Employee ownership is where employees buy the assets and undertaking of the business which
employs them or in some instances of a business in the same group. Generally this is done by 
buying or being granted shares or debentures in the company in question. A company limited by
shares is the most common form of company for business purposes. Employee ownership is 
facilitated by the employees becoming shareholders. The employees may then, if they choose,
establish a new company to purchase the assets (including any Intellectual property) of the
target company. 

It should also be noted that not all companies conform to the standard, which is discussed in
this essay. For example in Industrial and Provident societies, the control rests on a 
one member one vote basis. This is regardless of the number of shares owned by any single
person. If it is a ‘not for profit’ company, the ‘Registry of Friendly Societies’ considers
whether its constitution prevents a distribution of its shares and assets to its members.

Under the Companies Act, certain matters are left to Shareholders in a general meeting. For 
example amendments to the articles of association or memorandum of association, a resolution 
for voluntary winding up and alteration of the capital structure of the company are dealt with at 
general meetings, where shareholders are able to vote. Some issues are reserved for the 
shareholders to determine. Though it is greatly acknowledged that a Company’s affairs are 
controlled by its directors under its articles of association, there are circumstances where
the shareholders in a general meeting must take control of company affairs. For example where 
there is deadlock in the boardroom, an inability to fulfill a management role or if the board has
ceased to exist, the shareholders will take control. Though it is normally only a temporary 
measure, as once the board is able to function correctly it regains control, these are significant
powers. As shareholders normally provide investment too, they hold significant influence over
the company. As such, it is very important for company operations just who the shareholders 
are. 

Owning shares in a company simply means that a portion of the company is attached to each 
share and ownership rights pass with it. Ordinary shares carry one vote for each share and 
have a fluctuating value. Preference shares have a fixed value and have preferential rights to a
dividend and to repayment. They are often considered as a loan in the form of shares and are 
normally found in large companies. Debentures include stock, bonds and other securities of a 
company. They can be irredeemable or can carry rights of conversion to fully paid ordinary 
shares at a later date.

Employee share schemes are the normal vehicle for passing ownership to employees. Individual
schemes will be discussed further later. Employee share schemes are intended to encourage or
facilitate the holding of shares or debentures in a company by or for the benefit of:

“(a) the bona fide employees or former employees of the company, the company’s 
subsidiary or holding company or a subsidiary of the company’s holding company, or
(b) the wives, husbands, widows, widowers or children or step-children under the age of 
18 of such employees or former employees” 2


Establishing Employee Share Schemes

The Employee Share Scheme was established to promote greater economic success for the 
company. For that success to be shared amongst more people; the ‘bona fide’ requirement is a
key one. Companies cannot therefore manipulate the scheme for improper uses. For example 
in NZI Bank Ltd v Euro-National Corporation Ltd 3, the Court of Appeal would not allow the 
scheme to be a conduit for giving financial aid to major shareholders in order to dissuade them 
from selling their shares. Similarly the Court of Appeal also expressed the view that a very 
small class of beneficiaries could suggest impropriety. An exception to this is discussed later.
It is likely that English courts would be equally inquisitive.

Once it has been established that an employee share scheme can be established, it is up to the
company to decide how it is to do so. It may wish transfer shares gradually to test how it 
works, or it may wish to transfer shares quickly in order to raise capital. It must not however 
be thought that shares are merely bought and sold. Shares are often transferred as gifts or in 
exchange for loyalty or even as bonuses. 

The first of the major domestic exemptions provided for the promotion of employee share plans 
was in the Companies Act 1985, s153(4)(b) (inserted in 1989). This provides that Companies 
are able, in their bona fide interests to give financial assistance for the purposes of an 
employees’ share scheme. Since then, the Employee Share Scheme Bill was given royal assent
in November 2002 and has become the most significant piece of legislation promoting 
employee share schemes. As well as simplifying tax concessions which encourage transfer of 
shares into employee trusts, it has also allowed employee representatives to become trustees 
of share scheme trusts.

Why schemes are run-the tax break element

As well as the Employee share scheme bill (discussed above), major tax incentives for 
employee share schemes were also introduced by the UK Finance Act 2000.The creation of the
Share Incentive Plan (SIP) and the Enterprise Management Incentives (EMI) were the most
significant of these. Though these are the most common run schemes due to the tax breaks
given, it must not be thought that they are the only ones. Numerous schemes designed with 
everything from employees families to pensions are also participated in. 

The Share Incentive Plan was introduced to give employees shares in the company they work
for. Employees who acquire shares in the SIP gain in a number of ways. Employers are able to
offer free shares up to the value of £3000 per year. This will often be done as a way of 
performance related bonuses’, Christmas bonus’, joining bonus’ etc and is more tax efficient
than granting monetary bonuses. The reason for this is that shares granted under the SIP are
not subject to Income tax or National Insurance, provided they remain in the SIP for at least
five years. Growth in the value of shares, whether in exchange for remuneration or not, are not
subject to Capital gains tax. The scheme allows for partnership shares to be bought up the
value of £1500 per year or 10% of salary (whichever the lesser) and also allows employers to
match these shares by giving up to two free shares for each share bought. As attractive as this
is for employees, it is also attractive to employers. The SIP is a tax efficient manner of
keeping their employees happy and sometimes gaining extra capital through the sale of shares.
Employers are also able to claim Corporation tax relief for the value of the shares put into the
plan and also for the costs and running of it.

Whilst the SIP is particularly beneficial to large companies, the Enterprise Management
Incentive scheme is aimed specifically at small and medium sized companies. It specifically
helps these companies recruit and keep key executives. Any number of employees may be
granted up to £100,000 per option holder of tax advantaged options. A Company may grant
EMI options over shares with a total market value at grant of up to £3million. It must be
noted however that companies with gross assets exceeding £30 million or which carry out
certain businesses cannot grant EMI options. As discussed earlier, the bona fide requirement
of employee share schemes provides, amongst other things, that schemes cannot normally be
used to grant financial assistance to a small group of beneficiaries. The EMI is the exception
to this rule.

EBT’s and QUEST’s - the mechanism of a trust

Once it has been decided that shares will be transferred, the mechanisms can often play a
significant role in employee share ownership plans.  Major mechanisms include the Employee
Benefit Trust (EBT) and the Qualifying Employee Share Ownership Trusts (QUEST). EBT’s
and QUEST’s are now frequently established by employers for the benefit of their employees.
In the Trust fund, the trustees hold any capital sums that are paid to them. The trustees have
the discretion to apply for the income to be passed to one or more of the beneficiaries (the
employees). This will often be done on a performance related level or for any other particular
bonuses. EBT’s and QUEST’s can benefit employees and employers in different ways.

EBT’s and QUEST’s can benefit employees by allowing them to cash in some of their equity
(shares), by selling it to other employees in a tax efficient manner. This effectively creates a
mini stock exchange for employee shareholders. They can also provide a forum for educating
employees regarding their role as shareholders.

They can benefit employers by being an effective way of introducing share ownership into a
company gradually in order to test how it works. It can also be an effective way for the
company to borrow money in a tax efficient manner. The normal alternative would be by taking
out an expensive loan. Funds used to establish and run the trust along with the value of shares
put it in by the company, can be deducted in the calculation of corporation tax.

Since there was some uncertainty until the Employee Share Scheme Bill 2002, whether the
Inland Revenue would accept payments made by a company to an EBT as tax deductible, the
Government introduced its own form of EBT, the QUEST. It did more though than codify the
tax exemptions previously found in the common law. The QUEST, as a separate entity from
the shareholders may be used to buy shares from retiring shareholders. As mentioned earlier,
it is now possible under the Employee Share Scheme Bill 2002 for employee representatives
to be appointed as trustees to such schemes as the QUEST. The EBT or QUEST is recognized
as a shareholder itself.

Management rights of employee shareholders

Status as shareholders does not give a great deal of control over the company’s affairs. The
day to day running of the company will still rest with the directors. However, any changes to
the articles of association or memorandum of association would need approval by the general
meeting, at which shareholders would have a say. If for example though, the employees
wanted to restructure the company, they would not possess the requisite locus standi to do so.
The directors would have the duty to have regard to the interests of its employees (s309
Companies Act) but would have no legal obligation to obey its shareholders.

However, the directors would prefer a good working relationship with the shareholders. They
may need them for approval of a special resolution such as changing the objects of the
company (s4 Companies Act) or to alter the articles or memorandum of association. They
would also need them to be a happy workforce in order to work productively, which they may
not do if their interests were ignored. With the employee shareholders also providing easy
access to extra capital, the directors would want to keep on the right side of them. Though
there would be no legal obligation for the directors to take significant heed of the employee
shareholders, it would certainly be of practical use. Perhaps more significantly the directors
would be afraid of annoying employee shareholders where they have enough power to sack the
board or members on it (a simple majority is needed-s303 Companies Act). This could of 
course be potentially problematic if the directors feel it would be in the best interests of the
company to make decisions which would be unpopular with the workforce. 

Shareholders may struggle to enforce duties owed to them. Though they have certain powers in
regards to the articles of association and memorandum of association in particular, these
powers are generally limited to within the company. For example a shareholder has no right to
sue the directors for their actions because it is well established in Foss v Harbottle 4 that
wrongs done to a company can be litigated only by the company. Consequently it is normally
the directors who decide whether or not to litigate. 

For directors to protect themselves from potentially troublesome shareholders, it is sensible to
manipulate the company’s articles of association, before an employee share scheme becomes a
significant influence in the company. For example, if a director wishes to secure his or her
position on the board whilst making unpopular decisions, he or she would normally fear s303
of the Companies Act where a simple majority would be needed to dismiss him or her.
However, if the articles of association were to be manipulated to include an article requiring a
higher majority to dismiss a director, it would be more difficult to remove them. Though this
does contradict s303, it has been recognized in Bushell v Faith 5, that a weighted voting
clause of this type is valid. It would certainly be harder for a special resolution to insert such
a clause to be passed once employee shareholders have a vote.

Disposing of shares

One particular problem for employees is disposing of their shares. As employers do not want
shares to pass outside the company (that would involve becoming a Public Limited Company),
there is only an internal market of employees, the company itself and potential trust funds as
potential buyers. Though the vast majority of employee share schemes allow the company to
buy back its shares when the employee wishes to sell, things are not always straightforward. 

If the company is liquidated, owners of ordinary shares may find their assets worthless.
Owners of preference shares would normally join the queue of creditors near the back, and
may never see their money. This unfortunately, does mean that employees will often have to
consider accepting below the market value for their shares. 

The picture is however brighter for retiring owners. If shares are sold to a QUEST, and within
twelve months it acquires shares representing 10% of the ordinary capital, the vendor may
rollover any chargeable gain as long as the gain is vested in other assets. In that respect, 
those who hold large numbers of shares are generally more protected than those who do not
own many.

Unless all employees are willing to part with their shares, the company will not be able to close
the share scheme. Once ownership rights are passed, there is no going back unless the
employees consent.

The future of Employee Share Schemes

With recent legislation making it easier to run employee share schemes and offering more and
more tax breaks, the likelihood is that they will grow even more in stature over the coming 
years. By encouraging employees to have ownership rights over the companies they work for, it
is suggested that they will work harder in order to gain the full benefit from their shares. By
doing so, employers benefit as the company performs well. As productivity increases, the
economy improves and the public sees the overall benefits. As better productivity normally
leaves greater supply of products or services, customers may also benefit from reduced
prices.

The situation for investors can go down to the individual company in question. Normally
shareholders are the ones who play the role of investors. With the increase in employee
shareholders, it is less likely that there will be many professional shareholders around to
invest funds. The professional shareholders left are likely to own less of the company than
otherwise which could make it a less attractive investment. Those shareholders may see
employee participation in management as productive or counter-productive. If the employee
share scheme gives an unruly mob of employees applying the same pressure as a powerful
trade union, then investors may be wary. If, however, the employee share scheme leaves
employees working harder in order to see their shares grow in value, the company could
become a very attractive investment. 

Conclusion

Participation in Employee share schemes in large scales is still in its infancy, though likely to
grow quickly. As such, the major problem currently faced is ignorance of the rights associated
with the shares. Though shareholders rights are not significant and are normally only heard in
general meetings, employee shareholders do not know how to exercise these rights. The
existence of EBT’s and QUEST’s go some way towards advising employee shareholders but
will not be able to do enough until employee share schemes become more common than they
currently are. Whilst employees gain tax exemptions, until there is greater awareness of the
role of the shareholder, employees will not gain the full benefits of employee share schemes.

Employers receive the major benefits under tax exemptions and benefit from being able to gain
access to capital from shareholders who do not exercise their powers enough. As the company
is able to manipulate its articles and memorandum of association in its directors favor before
the scheme is introduced, it can find itself in a favorable position. Similarly to the employees’
lack of knowledge, companies will often not think of this. 

Employee benefit schemes are excellent methods of encouraging employee participation in
management and encouraging a growth in productivity. However, until they become more
widespread, the full benefits will not be experienced. With employees being the main group
ignorant of the rights attached to shares, it is the companies who at present benefit the most.

WORDS: 2994

Citations
1.	Rt Hon. Oliver Letwin, Shadow Secretary of State for Economic Affairs & Shadow
Chancellor of the Exchequer presenting to the Annual ProShare Employee Share
Ownership awards, 3 December 2003, Press Release
2.	Companies Act 1985, section 743
3.	NZI Bank Ltd v Euro-National Corporation Ltd (1992) 3 NZLR 528 NZ CA
4.	Foss v Harbottle (1843) 2 Hare 189
5.	Bushell v Faith (1970) AC 1099

Bibliography (other than above citations)
1.	Inland Revenue 2003 Budget: EBT’s
2.	Examples of Articles of Association and Memorandum of Association provided
3.	ProShare wesite www.proshare.org
4.	Job ownership website www.jobownership.co.uk/html/legislation.htm
5.	Company Law and Corporate Finance: Ellis Ferran
6.	Principles of Modern Company Law (seventh edtn.): Paul L Davies