Stock Market Guide to Employee Stock Options
Employee Stock Options have received increased publicity in recent years that coincides with their burgeoning popularity as a form of corporate compensation. One of the basic theories supporting the payment of employee stock options in lieu of cash income is that such payments make employees “owners” of the company.
Although this term greatly exaggerates any real ownership privileges acquired by employees, it is thought that by granting them the option to purchase the company’s stock at a fixed price, the employers will be inculcating in their employees an increased desire to see the company – and its stock – increase in value. The practice is seen as a convenient way to secure employee loyalty in an age where traditional methods of engaging employee support have faded. Often, employee stock options have provisions and restrictions on their conversion and tradability that are intended to secure long term employment and discourage quick profit-taking.
Employee stock options are also a convenient way for new companies that do not have large cash reserves to compensate valued members of their “team”. Even if the stock price increases, it is not the company that pays the employees when they cash in their stock options. Of course, the downside risk is squarely on the employees as their stock options may become worthless should the company run into difficulties that cause its stock price to collapse. A case in point is Enron, the giant electricity, natural gas, pulp and paper, and communications company that famously declared bankruptcy in 2001, wiping out the value of employee’s stock options in one fell swoop as the company’s stock price imploded from over $90.00 to a mere $0.30 per share.
Employee stock options differ from regular stock options in several ways. One is that the option’s exercise price is set to match the stock price on the day of issue for the option. This was a change instituted by regulatory agencies who found that some companies were back-dating the exercise prices in order to give the recipients an instant profit, as it were. The “vesting schedule”; a timetable that allows the options to be cashed, is typically from 3 to 10 years, leading to the ironic designation of employee stock options as “golden handcuffs”. This factor, along with restrictions on transferability (often they are only transferable in the case of the employee’s death) induces employees to remain with the issuing company and work for its prosperity.