Why Do Companies Issue Stock Options?

Options are an accepted part of the market for managerial services.

A company that issues stock options as a form of employee compensation seeks to align the incentives of employees with the success of the company, while limiting its payroll payout.

Incentives

One prevailing theory is: if an employee owns options, that employee has an interest in seeing the share value rise -- and the company has an interest in employees for whom that is an important consideration.

Function

In bad times especially, companies want to trim payroll.

Also, the use of stock options as part of a compensation limits the amount of cash the company must pay out to that employee. This gives the company greater flexibility in what it will do with its cash.

In July 2010, "Entrepreneur" magazine listed the payment of stock options to employees in lieu of cash as one way a small company experiencing a budgetary squeeze could "trim payroll without layoffs."

History

In 1993, Lou Gerstner signed on as CEO of IBM, and received as part of his compensation package 500,000 stock options. No one "suffered from indigestion or emitted a peep of protest" about this. "In fact, people applauded," as Roger Lowenstein noted. The public had become accustomed by that time to the idea that such options aligned incentives properly.

References

• "Origins of the Crash"; Roger Lowenstein; 2004.
• Entrepreneur: How to Trim Payroll Without Layoffs

Resources

• Yale Law School: Remuneration: Where We've Been