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By opening stock options to middle management and employees, it was assumed that better employee performance would be incentivized. As company stock prices go up, it creates a greater spread between the option price when it was granted to the employee and the hypothetical sale price at the end of the vesting period. Consistently better performance over a longer period of time would yield greater reward when the option is exercised. However, as Hall and Murphy again point out, "even if employees can increase the value of the firm, their share of that gain through their option holdings is very small. Combining this enormous free-rider problem with the risk imposed on employees through stock-based pay, it seems obvious that cash-based incentive plans based on objective or subjective performance measures can provide stronger and more efficient pay-performance incentives."
Despite many early statements in the life of the practice that employee stock options serve as an incentive to yield better performance, empirical data seems to show otherwise. "The prevalence of vesting periods for options and the requirement that employees immediately exercise options when they leave the company suggests that firms use options to retain employees." (Core, 2001) but, employee stock options also enormously increase the risk to the employee; such risk was, in the Old Economy, reserved primarily for upper level management, as they are the primary forces behind a firm's value. Oyer and Schaffer conclude, in fact, that the incentive for increased performance via employee stock options does not make up for the cost of the increased risk to the employee. Further, firms would in fact be much better off spending money on some other means of employee compensation that would not radically increase employee risk. (Oyer, 2005) They go on to argue that the actual motivations behind employee stock options are sorting (optimistic employees tend to accept employee stock options at a decreased cost of compensation to the company) and employee retention.
Swedish telecommunications company Ericsson seems to be a notable exception of a firm that has successfully altered the nature of its employee stock options from one of attempting to manage the labor market (attracting and retaining talent) to one of actual employee incentivization. Prior to 2000, employee stock option plans were a uniquely American means of allocating compensation. Because European markets tended to follow American New Economy trends, individual firms were able to make strategic selective adaptations. Glimstedt, Lazonick and Xie have extensively charted the steady transformation of employee stock options at Swedish telecommunications firm Ericsson, whose stock option plan shifted from:
"(a) the 1998 plan for a select group of high-level executives, comprising less than one-half of 1% of Ericsson's labor force, to (b) the 1999 plan aimed primarily at dealing as well with highly mobile high-level employees of New Economy firms that Ericsson had acquired in the U.S., and comprising <2% of the company's labor force, to (c) the 2000 plan that extended stock options to almost 8% of Ericsson's employees, but still with a primary focus on highly mobile U.S. labor, to (d) the 2001 -- 2002 plans that Corporate HR designed to manage the productive process rather than, given the downturn in the telecommunications industry, the labor market, and extended to 15% of Ericsson's worldwide employees, designated as KC, with the previous bias toward awarding options to U.S. employees virtually eliminated in the 2002 plan, to (e) the 2003 Board decision to eschew new stock option plans, with Corporate HR substituting instead a novel stock purchase plan that made use of the KC designation that had been central to the functioning of the 2001 -- 2002 plans."
With this transition, Ericsson shifted from managing its labor force to managing the productive process.
Lately, however, the market has seen a radical shift in the handling of employee stock options. The New York Times reported in March of 2009 that an increasing number of companies are lowering the price for employees to exercise stock options, including such significant brands as Starbucks, Google and Intel. This includes both repricing of stocks for employees currently holding options, and allowing employees to trade their current options for options with lower exercise prices. The trend has been particularly widespread among companies whose stocks saw significant decline during the 2008 financial crisis. (Glater, 2009)
The move can be advantageous for employees whose exercise prices are above the current market value of the stock (that is, the option essentially has no value, and, like so much of the real estate market is "under water"), but investors question the practice. If repricing actually results in a significant number of employees exercising their options, it can serve to drive up the value of the stock, however it also leads to dilution of the stock. This is somewhat analogous to the government printing more money as a means to solve the problem of American debt. Patrick McGurn of RiskMetrics Group contends that the move of repricing options is problematic on philosophical grounds as well, "A stock option is supposed to align the interests of employees and shareholders by putting them in the same boat. Repricing of options breaks that linkage." (Glater, 2009)
In a highly mobile labor market, employee stock options were developed as a means to attract and retain talent. Now that the labor market has shifted and lost its mobility, employee stock options seem to have shifted accordingly. In the American economic system and current recession, at least, employee stock options are no longer an incentive, but a burden to employees, forcing low-level employees of a firm to accept significantly higher levels of risk that far outweigh the corresponding means available to affect company performance, and as a substitution for actual (cash-based) compensation. Further, employee stock options relieve top executives of the consequences of poor performance as they artificially float the value of a company's stock independent from free market valuation. The complexity of valuing employee stock options aside, some companies, such as Ericsson, have demonstrated that employee stock options can themselves be fluid and shift according to the needs of the company and its labor force.
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