Pros and Cons of Employee Stock Options

Employee Stock Options (ESOs) are usually offered to people in the top management as part of their executive compensation package.  It may also be offered to other valuable employees.  An employee stock option is a call option on the common stock of the company.  ESOs allow, but do not obligate the employees to buy shares of the company.  If the company stock rises, holders of these options benefit.  Technology start ups have used ESOs to draw talent successfully.  Many talented employees have become millionaires.  

Companies offer ESOs to their employees in order to retain them.  It is believed to be a motivation for them to perform better.  Some management experts are of the opinion that turning employees into shareholders increases their loyalty to the company.  ESOs bring in a feeling of ownership among employees.  It motivates them to come out of “9 to 5” mindset and to make their company more competitive.  ESOs play a major role in increasing their efficiency and effectiveness.  They strive to maximize the profits of the company.  ESOs offer tax benefits for the organization.  

ESOs give an opportunity for employees to earn more than their salaries.  Some companies allow transfer of stock options to the children.  Companies purchased by employees (through ESOs) are more likely to be stable.  It is observed that companies offering ESOs have fewer incidents of employee litigation.  Employee turnover is lower in these companies.  ESOs also help the companies reduce their borrowing costs.  

ESOs increase financial risk.  Set up costs are substantial (approximately 3 to 6 percent of the total purchase price).  Regular appraisals are required to value the shares of stock.  These increase administrative expenses.  Companies are obligated to buy back the stock of retiring employees.  If a company has many employees nearing retirement age, this may become a burden.  ESOs cannot be sold by employees.  They are not like exchange traded options.  Also, a decline in the value of the options due to market fluctuations may lower the employee’s motivation.  

ESOs can benefit both the company and its employees if used appropriately.