With an employee stock option plan , you are offered the right to buy a specific number of shares of company stock, at a specified price called the grant price also called the exercise price or strike price , within a specified number of years. Your options will have a vesting date and an expiration date.
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You cannot exercise your options before the vesting date or after the expiration date. There are a few ways you can do this:.
Equity Compensation: When Startups Should Grant Restricted Stock, ISOs, NSOs, or RSUs
There are two types of stock options companies issue to their employees:. Different tax rules apply to each type of option. This is not necessarily the case for incentive stock options. With proper tax planning, you can minimize the tax impact of exercising your options.
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Your employee stock option plan will have a plan document that spells out the rules that apply to your options. Get a copy of this plan document and read it, or hire a financial planner that is familiar with these types of plans to assist you. There are many factors to consider in deciding when to exercise your options.
Investment risk, tax planning, and market volatility are a few of them, but the most important factor is your personal financial circumstances, which may be different than those of your co-worker.
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Keeping too much company stock is considered risky. Corporate executives need to consider this in their planning and work to diversify out of company stock. Securities and Exchange Commission. Fidelity Investments. Hall and Murphy argue that, in many cases, stock options are an inefficient means of attracting, retaining, and motivating a company's executives and employees since the company cost of stock options is often higher than the value that risk-averse and undiversified workers place on their options. In regard to the first of these aims - attraction -- Hall and Murphy note that companies paying options in lieu of cash effectively are borrowing from employees, receiving their services today in return for payouts in the future.
But risk-averse undiversified employees are not likely to be efficient sources of capital, especially compared to banks, private equity funds, venture capitalists, and other investors.
Issuance of Stock Options to Employees of the Company’s Subsidiaries
By the same token, paying options in lieu of cash compensation affects the type of employees the company will attract. Options may well draw highly motivated and entrepreneurial types, but this can benefit a company's stock value only if those employees- that is, top executives and other key figures -- are in positions to boost the stock.
The vast majority of lower-level employees being offered options can have only a minor affect on the stock price. Options clearly promote retention of employees, but Hall and Murphy suspect that other means of promoting employee loyalty may well be more efficient. Pensions, graduated pay raises, and bonuses - especially if they are not linked to stock value, as options are - are likely to promote employee retention just as well if not better, and at a more attractive cost to the company.
Fallacy 2: The Cost of Employee Stock Options Cannot Be Estimated
In addition, as numerous recent corporate scandals have shown, compensating top executives via stock options may inspire the temptation to inflate or otherwise artificially manipulate the value of stock. Hall and Murphy maintain that companies nevertheless continue to see stock options as inexpensive to grant because there is no accounting cost and no cash outlay.
Furthermore, when the option is exercised, companies often issue new shares to the executives and receive a tax deduction for the spread between the stock price and the exercise price. These practices make the "perceived cost" of an option much lower than the actual economic cost. But such a perception, Hall and Murphy maintain, results in too many options for too many people.
Equity Stock options explained for startup employees | Carta
From the perceived cost standpoint, options may seem an almost cost-free way to attract, retain, and motivate employees, but from the standpoint of economic cost, options may well be inefficient. Hall and Murphy's analysis has important implications for the current debate about how options are expensed, a debate that has become more heated following the accounting scandals.
A year ago the Financial Accounting Standards Board FASB announced that it would consider mandating an accounting expense for options, with hopes that this would be adopted early in Federal Reserve Chairman Alan Greenspan, investors like Warren Buffet, and numerous economists endorse recording options as an expense. Chamber of Commerce, and high-tech associations oppose "expensing" options. The Bush Administration sides with these opponents, while Congress is divided on the issue. Hall and Murphy believe that the economic case for "expensing" options is strong.
The overall effect of bringing the perceived costs of options more in line with their economic costs will be fewer options being granted to fewer people - but those people will be the executives and key technical personnel who can realistically be expected to have a positive impact on a company's stock prices.