Stock Options The phenomenon of Stock Options has had a dramatic rise and fall during the last 15 years or so. They have been hailed as a great way to share ownership, attract and retain employees in a tight labor market and "the fuel of entrepreneurial fire" (Malone, 2003). At the same time, they have been condemned as a major cause of the high-profile business scandals during 2000-01 and the subsequent down-turn in the U.S. stock-markets. In this paper, I shall describe what Stock Options really are, take a look at their history, advantages, and disadvantages and discuss their future in the business world.

What are Stock Options?

A stock option is a contract offered by the employer that gives an employee the right to buy or sell a certain number of shares in the company at a specific price within a certain period of time. The price at which the option is provided is called the "grant" or "strike" price and is usually the market price at the time the options are granted. The employee, having the stock option, is free to exercise his option at his/her option and the buying and selling of the stock is not binding. ("Employee Stock Option fact Sheet," NCEO Website)

As an example, a company may give an employee the option of buying a specific number of shares at the current market price of the share (say $10) on a specific date. The stock option contract would have a "vesting period" (say, one year) after which the employee has the option of selling the stock at the current market price. If the market price of the share has risen to say $15 after the vesting period, the...

The stock option also has an expiration date after which the right of the employee to buy / sell the stock ends; hence if the share price falls (or remains the same) compared to the "strike" price in the period up to the expiration date, the stock option is worthless for the employee. However, the employee does not suffer a loss in any case.
History of Stock Options

Stock options first began to appear in the U.S. businesses in the 1950s, but at the time they were generally modest in size. The trend of offering stock options (particularly to the top managers) began to take off in the late 1980s and by the turn of the century the typical CEO of financial sector firm was receiving stock options worth $55 million a year -- more than 30 times his salary. (Shapiro, 2002). The offer of stock options became more widespread and the NCEO estimated that as of 2001, up to 10 million employees were receiving stock options in the U.S.

Advantages of Stock Options

Stock Options are considered to be an effective tool to align the interests of the employees with that of the share-holders. Since the rise in the share price directly benefits the employees having stock options, it is a great motivator for them to work hard to add value to the company stock. Stock options are particularly suited to promising new high-tech companies that are able to attract technical and managerial talent without incurring a hefty payroll, as new recruits accept a…