The Importance of Stock Options in a Company
Stock option plans allow employees the right to buy the company's shares at a fixed price within a certain period of time. These plans are usually offered to senior management and key employees that hope to profit from the options once the company goes public or there is a significant change in the market price.
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Facts
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Employee stock options are call options that give holders the right, but not the obligation, to exercise the option and acquire the underlying stock at a specified price (the grant or strike price) before an expiration date. If the underlying stock increases in value above the strike price, the option becomes "in the money;" otherwise, it is "out of the money." You can exercise an in-the-money option, buy the stock at the lower strike price and sell it at the higher market price to profit from the difference. If it's an out-of-the-money option, you'll hold on to it hoping the market price will rise in the future.
Recruitment
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Many companies use employee stock options plans to recruit, retain and compensate employees. Startups, for example, can offer the promise of a lucrative payday in the future in exchange for less-than-market salaries in the present. Stock options align the company's interests with its employees. There is usually a vesting period that specifies when and how much of the granted options can be exercised. This encourages employees and executives to stay with the company longer and help it grow. Stock options are often the most significant part of senior management compensation packages. While the base salary may be in the hundreds of thousands for a chief executive, the total pay can be in the millions after profits from the exercise of options.
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Financial
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Stock options are common among early-stage companies that need to preserve cash. The employer gives up a higher salary elsewhere in return for a potential windfall in the future. There are many stories of employees, including secretaries and personal assistants, becoming extremely rich after a startup goes public. After the dot-com crash of 2000 and the financial crisis of 2008, many stock options became out-of-the-money as a result of market prices falling below strike prices. According to the New York Times, executives at dozens of public companies, including Starbucks and Intel, took steps to "lower the prices that their employees would have to pay to convert options into stock." While this kind of repricing may not help shareholders, it can motivate employees who may have watched the value of their options dwindle in a market downturn.
Considerations
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Employee stock options are not like those on the Chicago Board Options Exchange. They can only be exercised. You cannot trade them. Typically, the company makes arrangements with one or more brokers to facilitate the exercise of these stock options.
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