Jamil Khatri Partner Bangalore 7 March 2006

2. 2 Why ESOP’s? Form of Compensation Retention, Growth and Value Gives an employee a stake in the Company Builds loyalty and forms incentive for an employee to identify his growth with the growth of the Company Resurgent stock markets make it attractive Peer Pressure When one company adopts it, others are forced to join Non-cash expenditure for the Company

3. 3 Forms of ESOPs Options Gives an employee the right to buy or sell the stock at a specified price by a specified date Restricted Stock Shares are given with vesting conditions Stock Appreciation Rights Unlike an option, the employee is not required to pay an exercise price to exercise them, but simply receives the net amount of the increase in the stock price

4. 4 Accounting : Indian GAAP

5. 5 Accounting for ESOP’s Unlisted companies Accounting recommended by guidance note for all grants on or after 1 April 2005 Accounting policy decision to follow intrinsic value method or fair value method Listed companies Mandatory accounting, governed by (Employee Stock Option Scheme) Guidelines,1999 Accounting policy decision to follow intrinsic value method or fair value method

6. 6 Intrinsic value Market price (listed companies) or fair value per share (unlisted companies) Exercise price Price which the employee is required to pay Intrinsic value Difference between the market price/fair value and the exercise price Cliff or graded vesting conditions Compensation cost recognition over the vesting period

7. 7 Fair Value method Valuing options using Black Scholes formula or similar valuation method Time value element is considered in this process Key assumptions and its relationship with option values:

8. 8 Fair Value method – disclosure requirements Disclosures in the directors’ report / financial statements for fair value when company has followed intrinsic value method for accounting Difference as compared to using fair value method as also impact of difference on profits and EPS.

9. 9 Forfeitures Vested Options Listed companies - Compensation cost recognised earlier is reversed on the date of forfeiture / lapse Unlisted companies – compensation cost recognised is not reversed on date of forfeiture / lapse Unvested Options Compensation cost recognised earlier is reversed on the date of forfeiture Estimation No guidance for estimation of forfeitures on the date of grant for accounting purposes

10. 10 Use of ESOP trusts Under a typical structure Board of Trustees is controlled by the Company Company gives a loan to the trust Trust uses the funds to buy shares of the Company, either directly from the Company or from secondary market purchases Employees of the Company are given options. Decision to grant options is controlled by the compensation committee of the Company On exercise of the options, the trust issues shares to the employee Cash received on exercise is used to repay loan taken by the trust Controlled trust would not be consolidated in the financial statements Compensation cost to be recorded as if the options were granted directly by the Company Effect on EPS assuming treasury stock transaction

11. 11 Accounting : US GAAP

12. 12 APB 25 – old accounting rules Intrinsic value method Fixed awards / plan Variable awards / plan Effect of forfeitures / lapse Repurchase features Income taxes

13. 13 FAS 123 – proposed in the mid-1990’s Based on the premise that the intrinsic value method does not capture the true value of employee stock options Significant debate & opposition from companies (especially start-up companies, technology companies) US Senate threatened to intervene. FASB had to back-off FASB specified that though the ‘fair value’ method was preferable, companies could decide to follow the existing ‘intrinsic value’ method Disclosure mandated for effect of following the fair value method Minimum value method for the non-public entities Almost all companies elected to follow the existing intrinsic value method Since options were ‘fixed’ & ‘at-the-money’, no cost recorded

14. 14 Current environment (last 2 years) Significant pressure on corporate governance issues Media attention to “excessive” compensation through stock options Approximately 400 companies announced their intent or have adopted the recognition provisions of FAS 123 voluntarily NYSE & NASDAQ now require shareholder approval of almost all equity plans IASB projects Revival of the FASB project Opposition from the technology sector, support from investor groups Debate shifted to ‘valuation’ of options Not market traded Long-term Restrictions on vesting / transfers

15. 15 SFAS 123R – fair value accounting Fair value accounting mandatory from the effective dates Intrinsic value accounting vis a vis fair value accounting Time value element Very complex guidance under intrinsic value rules Move towards fair value accounting as in all other cases Option value to reflect stock market dynamics like volatility Comparability with others Minimum value method for non-public companies withdrawn

16. 16 SFAS 123R – effective dates Effective Date Public entities (only SEC Registrants) - first annual reporting periods that begin after June 15, 2005 Other Public entities - interim or annual reporting periods that begin after June 15, 2005 Nonpublic entities - beginning of annual reporting periods that begin after December 15, 2005 Early adoption is encouraged provided that financial statements for those earlier interim or annual periods have not been issued

17. 17 SFAS 123R – transition provisions Transition Public entities may use: Modified Prospective Application - recognize cost related to all new, modified or repurchased awards after effective date and for the unvested portion of outstanding awards using amounts determined for Statement 123 purposes, or Modified Retrospective Application - Restate (a) all prior periods or (2) prior interim periods in year of adoption using amounts determined for Statement 123 purposes Nonpublic entities that applied the minimum value method – Prospective Application Apply to new or modified awards issued after effective date Continue to apply existing literature (APB 25 or Statement 123) to prior awards

18. Share-Based Payment - Grant Date Grant date The employee and employer have a mutual understanding of the key terms and conditions of the award Under the proposed Staff position 123R-b Mutual understanding criteria is presumed to be satisfied at the date award is approved under relevant corporate governance requirements, if other elements of the definition are met and the following conditions are also met: The recipient is unable to negotiate the key terms and conditions of the award The award’s key terms are expected to be communicated to the employees within a relatively short period of time after the date of approval.

19. 19 SFAS 123R – valuation models Suggested valuation models include Black-Scholes-Merton Lattice (binomial) Monte-Carlo No preferences to any model Each assumption and estimates must be ‘reasonable and supportable’ Recent comments by SEC’s office of Economic Analysis on use of market based measures to value options

20. 20 SFAS 123R – Compensation cost recognition Companies have to make a policy election between ‘straight line’ versus ‘pro-rated’ compensation cost recognition of graded vesting awards Level of forfeitures must be estimated in recognizing compensation cost

21. 21 SFAS 123R – equity or liability Equity-classified awards: Fair value determined at grant date Value per award is not subsequently adjusted Compensation cost recognized over requisite service period Liability-classified awards: Fair value determined at grant date Fair value remeasured at each reporting date until settlement Cumulative compensation cost will be intrinsic value of award at settlement Intrinsic value (variable) accounting permitted for non-public companies

22. Acceleration of vesting Acceleration of vesting of an equity-classified award without changing any of the other terms of the award does not generally result in an increase in the award’s fair value The remaining unrecognized compensation cost is immediately recognized at the time the awards vest Acceleration of vesting in conjunction with termination of employment may result in an incremental cost on the date of modification Acceleration of vesting done before effective date of SFAS 123R accounting is reached Is permissible but requires adequate disclosure as mandated by SEC

23. Business combination Accounting for exchange of options in a business combination in the following scenarios (earlier guidance of EITF 00-23 and FIN 44 is retained): Acquirer issues vested award for acquiree’s vested award Acquirer issues vested award for acquiree’s un-vested award Acquirer issues un-vested award for acquiree’s vested award Acquires issues un-vested award for acquiree’s un-vested award Modification accounting (only incremental cost) v. FIN 44 accounting

24. Key difference between IFRS and US GAAP Recognition of cost for graded vesting conditions: IFRS – accelerated method US GAAP for awards having only service condition the companies can elect straight line method or accelerated method as an accounting policy For other awards accelerated method Other accounting treatments are largely similar

25. 25 ?

26. 26 Thank You