New Accounting Rules for Employee Stock-sharing
Swan Song for the High-tech Gold Rush?
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Swan Song for the High-tech Gold Rush?By Jimmy Hsiung
From CommonWealth Magazine (vol. 378 )
On 30 July a local newspaper ran a front-page lead story detailing Asustek Computer Inc.’s alleged plans to implement an across-the-board employee pay increase of 30 percent beginning in the second half of the year in response to new accounting rules, set to take effect next year, that will require companies to report employee stock bonuses as an operating expense.
The paper was on the newsstands until noon before Asustek took action to clarify. In a public announcement through the Taiwan Stock Exchange headlined, “No basis to claim of 30 percent pay hike in response to expensing of employee bonuses,” Asustek insisted, “Future comprehensive employee compensation planning will consider not only relevant government rules and regulations but increasingly refer to industry standards and adopt a differential management approach to ensure the welfare of our employees while maintaining relative competitiveness through offering substantive basic salary and performance bonuses.”
For years employee bonuses in the form of company shares have been seen as the wellspring from which Taiwan created its high-tech industry achievements and assembled a top-flight talent pool as well as securing Taiwan’s place within the global computer, communications and semiconductor industries.
But the wellspring that has nourished countless tech enterprises and enriched a new generation of electronics tycoons has left many companies hesitant about how to proceed in the future.
At Asustek and countless companies across the technology sector, from semiconductors to electronics, whenever the subject of the new accounting rules comes up, an attitude of hesitancy immediately surfaces, as enterprises size up how the competition intends to proceed.
“There’s no need to be the early bird in something like this,” laughs a top executive with a local semiconductor packaging and testing company. “First you wait and see how the major industry movers handle it.”
The major industry movers of which he speaks, of course, could only mean Taiwan Semiconductor Manufacturing Corp. Indeed, TSMC chief financial officer and spokeswoman Lora Ho made herself the industry bellwether on the handling of the expensing of employee bonuses at a TSMC investors seminar on July 26.
Phenomenon 1: Set Ratios and Quarterly Reporting
TSMC’s Ho revealed that the company would henceforth allocate 15 percent of after-tax earnings to be used for employee bonuses. Starting next year, meanwhile, TSMC would charge employee bonus expenses against earnings on a quarterly basis. TSMC’s workforce is generally divided into two main groups, production/administration personnel and R&D personnel. Following adoption of the new accounting rules, bonus expenses for the two employee groups will be reflected in “personnel costs” and “R&D costs,” which will affect the company’s “gross profit ratio” and “operating profit ratio.”
But even a perfect response would still raise eyebrows. Off the record, TSMC employees grumble that, under the new rules, total employee bonuses this year would have comprised between 25 and 26 percent of after-tax profit. In comparison, the 15 percent allotted for next year will clearly be a drop-off.
So how in the world does one set a fixed employee bonus ratio across such a complex industry? With the dawning of this new era in Taiwan’s technology industry, upper management and the workforce are already tacitly jockeying for position.
Foreign investors have long viewed employee stock-giveaway bonuses with disdain. Because companies were not required to book the giveaways as an expense and employees were not burdened with tax liability on their bonus shares, foreign investors view stock bonuses as “fattening the workforce at the expense of the shareholder.”
But the implementation of the new rules next year is sure to change the face of Taiwan’s high-tech industry.
The rule change will initially have the greatest impact on the chip design industry. Particularly in this sector, where talented personnel have always been fundamental to operations, employee stock bonuses have been the stuff of legend.
In June, for example, OTC-listed chip designer Ralink Technology Corp., a designer of network communications chipsets, announced at its shareholder meeting that employee bonuses for the preceding fiscal year had totaled 5,904 lots of 1,000 shares, an average of 48 1,000-share lots per employee. If value were calculated based on Ralink’s NT$312 share price at the close of the OTC market that same day, it came to an average bonus value of a cool NT$15 million per employee, far in excess of the bonuses on offer at industry leader MediaTek Inc., which averaged NT$8.05 million in market value per employee.
One thing is for certain, however, once the new accounting rules take force, tens of millions in bonuses will simply evaporate.
But in the talent-dependent chip design sector, outstanding employees are the backbone of competitiveness. According to Credit Suisse analyst Chang Hsing-yi, based on the unofficial psychological targets assessed by many across the industry, average employee bonuses for the chip design industry after the new accounting rules take force will account for around of 30 percent of after-tax profit.
Phenomenon 2: Competitiveness Laid Bare
When the new rules are introduced, a given enterprise’s competitiveness will be exposed for all to see.
In the highly charged battle for top-flight employees, the percentage of profit to be used for employee bonuses has become a trump card no one will reveal lightly.
“No one is in a rush to fix an expense ratio right now,” SpringSoft chief financial officer and spokesman Wu Sen-tian explained. “Instead, what you want to do is ‘benchmark’ competitors and institutional investors, and also consider labor cost, financial, product and other fundamental structural issues across the global industry, and then examine it as a total package.”
In fact, as early as last year, SpringSoft, like many other chip designers, began to study its competitiveness and pay structure relative to other companies in the same sector and industry at large, Wu reveals.
“We need to stay on top of the pay standards out there for workers at different levels,” Wu says. “Otherwise our employees will definitely react!”
In the future, tech companies will have a much more detailed picture of the production value of employees and the dynamic relationship between workforce costs and competitiveness.
Phenomenon 3: Strong Rise, Weak Weeded Out
Quality companies will stand out even further with the adoption of the new accounting rules. Companies like MediaTek and Novatek that can expect 15 to 25 percent sales growth and annual profit growth and whose employee bonuses have generally hovered between 20 and 30 percent of earnings will be somewhat less affected by the rule change, Credit Suisse’s Chang says.
“Quality companies have the capital on hand to take care of their workforces,” she says. “It’s some of the small and medium-sized chip design companies where profit is less than ideal that are most worrisome.”
But, she adds, the effect on foreign institutional investors will likely be minimal, as many have long been counting employee bonus payouts as expenses when evaluating the share value of individual Taiwanese stocks.
“We’re all very clear on which stocks in the past have posted an official earnings per share of NT$4 or NT$5 but which were actually on the brink of being in the red,” Chang says, at once elucidating the reality.
Phenomenon 4: Short-term Losses, Long-term Gains
According to research conducted by Merrill Lynch in August 2006, based on average stock price estimates for the 12 months of 2005, after the new accounting rules take force, average profit for all listed companies will fall by 14 percent, with the average dilution among companies in the electronics sector even more severe at 27 percent.
But the cloud does have a silver lining. Even though it appears that electronics companies will bleed up to 30 percent of profits as a result of the new rules, old industry hands continue to insist that nimble Taiwanese companies have always been able to rise to the challenge.
“Relax! Between now and the first quarter of next year businesses will definitely come out with packages of countermeasures so fast it will make your head spin,” says one top executive with a Taiwanese company who is a long-term resident of Shanghai.
In fact, following the Securities and Futures Commission September 2006 approval of measures allowing companies to buy back treasury stocks for distribution to employees and to offer employee stock options below market price, the degree of profit dilution resulting from employee bonuses had already been dramatically reduced in the eyes of foreign investors.
In a research report released earlier this year, Dickson Ho, head of research at Morgan Stanley Taiwan, noted that after the imposition of the new rules the average dilution ratio for Taiwan electronics companies will be around six percent, as opposed to the estimated level of around 20 percent.
Phenomenon 5: Wave of Attrition
With the implementation of the new rules, a wave of employee attrition can be expected.
According to Kirk Yang, chief analyst for hardware and components in the technology research division of Citigroup Global Markets Asia, an inevitable accompaniment to the imposition of the new rules will be a “whirlwind” among upper executives at Taiwan tech companies.
“This is a time where enterprises are seeking to hammer out new work agreements with employees while those same employees are out seeking new contract opportunities,” Yang says.
However, precisely because of the arrival of the new rules, jumping ship has become something not to be done in haste.
“It’s no longer a question of jumping or not jumping ship, and it’s not a matter of switching to a new company and riding the rising tide,” says Acer Computer founder Stan Shih. “Right now the entire industry is in contraction.”
Reality, however, begets reality. The battle within the innovation-dependent tech industry for top-flight personnel will not simply cease, even temporarily, and with the new rules the norm will tend toward companies paying out cash bonuses to entice a quality workforce. This has become increasingly evident since Hon Hai Group chairman Terry Gou led the way two years ago in introducing an employee vested stock trust to serve as the “capital” underpinning for employee bonuses.
Not to be outdone, last year Asustek chairman Jonney Shih and company founders Tong Tsu-hsien and Ted Hsu introduced their own employee stock trust.
Regardless of whether the majority of companies are tight-lipped about their plans for handling the rule change, it is evident that the industry is adopting a number of measures including salary raises and cash bonuses to meet the challenge. Although the costs of top-flight personnel may henceforth be even pricier, companies will now have a clearer picture of the “book value” of each individual employee.
Translated from the Chinese by Brian Kennedy