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Employee Stock Options are stock options for the company's own stock that are often offered to upper-level employees as part of the executive compensation package, especially by American business corporations. It is also sometimes done for non-executive employees, especially in the technology sector, in order to give all employees an incentive to help the company become more profitable. Because stock prices are related to corporate earning, the employees have an incentive to increase earnings, in order to make the price of the company's stock rise, and therefore increase the value of the employee's stock options. This increase in earnings can either be done in reality, or possibly by the use of creative accounting. Conversely, a company may offer stock options to employees to help reduce staff turnover, if the job in question is in great demand. This happened frequently in the so-called dot-com boom of the late 1990s.
Employee stock options differ from the options that are traded on exchanges as securities primarily in the time frame under which they can be exercised. Employee stock options typically allow an exercise timeframe of up to ten years, whereas the longest time to expiry for exchange traded options is typically 2 years. Thus employee stock options are similar to warrants.
Stock options are sometimes jokingly referred to as "golden handcuffs" (in the same vein as golden handshakes or golden hellos), especially in a strongly rising market - the employee may feel compelled to work out the time until they are able to liquidate the stock even if they might otherwise prefer to leave the company.
Types of Employee Stock Options
Stock options granted to employees are of two forms, that differ primarily on their tax treatment. They may be either:
- Incentive stock options (ISO's)
- Non qualified stock options
Expensing of Employee Stock Options
According to current US generally accepted accounting principles, stock options granted to employees do not need to be charged as an expense on the income statement when granted, although the cost is disclosed in the notes to the accounts. This allows a potentially large form of employee compensation to not show up as an expense in the current year, and therefore, currently overstate income. Many assert that over-reporting of income by methods such as this by American corporations was one contributing factor in the Stock Market Downturn of 2002.
Many people argue that stock options should not be treated as an expense. Every other expense decreases the net worth of the corporation, whereas stock options, when exercised, actually increase it. Exercised stock options do not lower the income of the corporation, but "cut more slices into the pie" of earnings per share. Those who are against stock option expensing say that the diluted earnings per share metric (the amount of income divided by all outstanding shares and all shares that would theoretically exist if all the stock options were used) clearly shows the economic effect of stock options. For example, Martin J. Whitman argues that while stock options may dilute the value held by each of a company's existing shareholders, they are of little concern to creditors, and that "GAAP... ought to be geared toward meeting the needs and desires of creditors rather than the the needs and desires of short-term stock market speculators." [1] (http://www.thirdavenuefunds.com/3Q04.pdf)
Under International Accounting Standards, an estimate of the cost of stock options granted to employees is charged against profit as an expense in the accounts.
See also
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