Stock Options As a Motivator
Stock options are a great tool to attract and keep the best employees and motivate them to work hard. Their issuance benefits both the employees and the company.
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Features
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A stock option is an option to buy company stock at a specified price after a specified period of time. Most stock options have a vesting schedule: they vest, or become exercisable, over a period of time, as long as the employee remains with the company. For example, an option to buy 1,000 shares may have a 5 year vesting schedule, meaning that each year 200 options become exercisable. The option stock price is always set below the current market stock price.
Benefits
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Stock options can be very lucrative. Theoretically, there is no limit to how high a stock price can go, and since the option locks in the employee's cost of acquiring the stock, any amount above it is pure profit. During the Internet boom in the late 1990s many technology company employees became paper millionaires through stock options when their company's "hot" stocks went through the roof.
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Effects
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Since stock options can be so lucrative, they help companies attract the best employees. Stock vesting helps companies retain employees, because they forfeit unvested stock options if they leave. Stock options also motivate employees to work hard because their contribution helps push the stock price higher. Companies also save on compensation if options are given in lieu of income. Employee stock options do not cost companies anything since employee stock option profits are produced by the market. In fact, when an employee exercises stock options, the company gets cash equal to the stock option price.
Disadvantages
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Stock options may be a large part of the overall employee compensation package, but there is no guarantee that the stock price will appreciate. If it does not, or if it goes down instead, not only do employee options become worthless, but salaries begin to look much less attractive without them. A falling stock price may motivate employees to look for greener pastures.
Potential
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Stock options are easy to exercise because many brokers finance them. For example, an employee has 1,000 vested options to buy XYZ at $20. The stock is currently selling at $40. If the employee does not have the cash, the broker will advance the $20,000 to the company for the employee to exercise the options. Once the stock is delivered to the broker, the employee balance in the account becomes as follows: 1,000 shares of XYZ at $40 = $40,000 less $20,000 margin loan equals $20,000. This is a benefit to both employee and employer as neither incurs any out of pocket expenses in the transaction.
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