Employee Stock Option Plans (ESOPs) are powerful structural instruments designed to align human capital with shareholder wealth generation. However, corporate boards, founders, and compliance officers frequently ask a fundamental question: “Can we set the ESOP Exercise Price lower than the nominal Face Value of the share to maximize employee benefit?”

Under the Indian corporate legislative framework, the absolute answer is No.

Setting an Exercise Price below Face Value constitutes the issuance of equity shares at a discount. This practice is strictly prohibited by law, carrying severe statutory penalties and voiding the transaction.

Before exploring the statutory prohibitions, we must define how these two distinct pricing metrics interact across the ESOP lifecycle:

• Face Value (Nominal Value): This is the fixed corporate value of a single share as defined in the Capital Clause of the company’s Memorandum of Association (MoA). In India, companies typically structure their share capital with a nominal Face Value of ₹1, ₹5, or ₹10. This value remains static unless altered through a formal corporate action like a stock split or a consolidation.
• Exercise Price (Strike Price): This is the predetermined price an employee must pay out of pocket to convert a vested option into an actual equity share. This price is locked in on the Date of Grant by the Board of Directors or the Nomination and Remuneration Committee (NRC). It can be set at a premium, at the current Fair Market Value (FMV), or discounted—but it is strictly capped by a statutory floor price.

1. The Statutory Framework: Primary Acts and Absolute Prohibitions

A. Section 53 of the Companies Act, 2013 – The Absolute Prohibition on Discounts

The legal barrier preventing an Exercise Price from dropping below Face Value is anchored in Section 53 of the Companies Act, 2013. This section eliminates the flexibility companies enjoyed under the previous 1956 Act to issue discounted shares with regulatory approval.

Section 53(1): Except as provided in section 54, a company shall not issue shares at a discount.

 

Section 53(2): Any share issued by a company at a discount shall be void.

Because an ESOP exercise forces a company to issue brand-new equity shares from its unissued authorized capital, setting an Exercise Price below Face Value is legally defined as issuing equity at a discount. Consequently, any such allotment is void from its inception (void ab initio) under corporate law.

 

B. Section 54 Exceptions: Sweat Equity vs. ESOPs

Section 53 explicitly carves out only one operational exception for employees: Sweat Equity Shares under Section 54.

While a company can issue Sweat Equity shares at a discount or for consideration other than cash (to reward intellectual property rights or value additions), this carve-out does not apply to ESOPs.

ESOPs are governed by Section 62(1)(b) of the Companies Act, 2013, read alongside Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. These provisions offer no exceptions for below-face-value pricing.

 

2. The Cost of Non-Compliance: Section 53(3) Penalties

Violating Section 53 carries severe financial consequences. Under current regulations, if a company attempts to allot shares below Face Value:

• The company and every officer in default are liable to a penalty equal to the amount raised through the illegal issue of shares, or ₹5 Lakhs, whichever is less.
• The company must refund all monies received to the respective option holders, along with interest at 12% per annum from the exact date of issue.

3. The SEBI Position for Listed Entities

For public companies listed on recognized Indian stock exchanges (NSE/BSE), the regulatory floor is reinforced by the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021.

Regulation 18: Pricing Discretion & Floor Restrictions

Under SEBI guidelines, the Board of Directors or the NRC retains the commercial freedom to formulate its own pricing policy. The company can grant options at a steep discount relative to the current market price (CMP) to create a high-value incentive.

However, SEBI explicitly aligns this pricing freedom with the limits of the Companies Act: 

                      Minimum Allowable Exercise Price= Nominal Face Value of the Share

If a listed tech enterprise has a CMP of ₹1,500 and a nominal Face Value of ₹10, the Board can legally set the Exercise Price at ₹10 (granting a ₹1,490 discount). However, setting the Exercise Price at ₹9 remains illegal and non-compliant.

 

Financial and Structural Risks of Below-Face-Value Issuance

1. Capital Impairment and Accounting Red Flags

Under the ICAI Guidance Note on Accounting for Employee Share-based Payments and Ind AS 102, companies must account for the fair value of options as an employee compensation expense over the vesting period.

If a share is issued below its nominal value, the Share Capital Account cannot be credited with its true legal amount without creating a deficit. This creates an unabsorbable accounting entry that leads to statutory audit qualifications.

2. Tax Risks for Employees under the Income Tax Act

Under Section 56(2)(x) of the Income Tax Act, when an employee exercises options, the differential value between the Fair Market Value (FMV) and the Exercise Price is taxed as a Perquisite under salaries.

Attempting to price an option below Face Value creates a highly irregular valuation base. This triggers immediate scrutiny from tax authorities, potentially leading to the reassessment of the entire corporate valuation pool.

Compliant Strategic Alternatives for Corporate Boards

Companies do not need to violate the law to make equity packages highly attractive. If a board wants to provide an exceptional financial upside to its workforce, it can use three legally sound strategies:

Strategy 1: Granting Options Exactly at Face Value (The “Par Value” Grant)

This is the most common approach for early-stage startups and unlisted growth entities. By matching the Exercise Price exactly to the Face Value (e.g., locking in a strike price of ₹10 for a share worth an FMV of ₹500), the company delivers maximum immediate Intrinsic Value to the employee. This approach stays perfectly within the boundaries of Section 53.

 

Strategy 2: Corporate Action Structuring (Stock Splits)

If a company’s high Face Value (e.g., ₹100 per share) makes a face-value ESOP package too expensive for employees, the board can execute a Stock Split. By splitting a ₹100 Face Value share into ten shares with a ₹10 Face Value, the company proportionally lowers the legal floor price. This makes the out-of-pocket exercise cost highly affordable for the workforce.

 

Strategy 3: The Cash-Less Exercise Mechanism

To eliminate out-of-pocket funding stress for employees, listed entities can integrate a cashless exercise facility into their ESOP schemes.

Upon vesting, the company’s designated broker sells a small portion of the employee’s shares on the open market to cover the total Exercise Price (which remains Face Value and the tax withholding obligations. The remaining net pool of shares is then credited to the employee’s demat account, without requiring any personal cash investment.

In the Indian regulatory landscape, attempting to push an ESOP Exercise Price below Face Value is a critical legal error that voids the equity allocation.

The statutory frameworks across the Companies Act and SEBI regulations provide ample flexibility to reward talent through deeply discounted option grants, provided the nominal face value is treated as an absolute floor.

Corporate boards and founders must design their ESOP schemes using compliant strategies—such as Par Value grants or structural stock splits—to protect their cap table, shield their employees from tax risks, and maintain investor trust.

Article by:CS Neha Sarpal (7053715771)

Disclaimer: This article provides a comprehensive overview of equity incentives under Indian law for informational and educational purposes. It does not constitute formal legal or tax advice. Corporate boards must consult an independent Registered Valuer and qualified legal counsel to customize schemes matching their specific corporate structures.