Stock Options
Stock options as a term is getting a mention in almost every offer letter sent out in the present world, especially for the executives and senior management positions. According to Hall (2000), the choice, of the employee, to decide whether or not to buy the shares of the employer organization on a particular price, is a broad meaning of the term stock options. The specific price in these options is termed as the exercise or strike price. These options are given to the employee by the employer wherein there is no pre-requisite that the employee needs to buy the stocks, rather it is a matter of choice for the person. Furthermore, these options only offer its owner to earn profit by selling them at higher price, whenever there is a chance. The employer does not give the individual the stocks through this mechanism, which is the key differentiator between giving the options to the employee and granting him/her the stocks. Thus employee does not have any dividend benefit and the gains below strike price do not exist.
The options, based on the strike price, can be offered to the employee in two ways – out of the money, and in the money (Hall, 2000). Former is an approach where the employee is given the options when the market price of the stock is same as that of the strike price. On the other hand, if the individual gets to buy the stocks at a price less than the prevailing market price, then it would be termed as in the money option. Out of money is more commonly used by organizations, since the latter involves more outflow for the company, and is a discount option.
As per Hall (2000), there are various benefits of using the options approach for compensating the employees. Firstly, it motivates the employee to work towards a sustained growth of the organization, as the options generally have a lock-in period and are cashable after that in a phased manner over a certain number of years. In addition, with restrictions on passing on the options to anybody else and the performance of company affecting the stock price, it makes all the sense for the company to give options to the executive. Lastly, the organization saves a lot of cash by not using the same as a means of compensation.
The stock plans offered to the employee can be grouped into three categories, based on the approach adopted by the company. These are (Hall, 2000) –
1. Fixed Value – As the name typically suggests, it is about offering the options of a constant value to the executive yearly, irrespective of the performance of the organization. However, the net gain or loss to the employee changes and is generally inversely proportion to the stock price movement.
2. Fixed Number – In this case the number of options given to the employee remain constant over a period of time. The employee’s earnings through the options go up if the price in the stock market increases and reduces if the same goes down.
3. Mega-grant – The third type of plan gives the receiver a large number of options in one go, rather than every year for a certain period of time. Here both the option exercise price as well as the quantity of the same are laid out at the beginning.
All the options have their own pros and cons, and how and why a plan is to be selected depends on a number of factors of the company and employee. Some of these factors are – Type of Plan
Characteristic Fixed Value Fixed Number Mega-grant
Number of Options Variable Fixed Fixed (net present value)
Value of Options Fixed Variable Fixed (fixed strike price)
Options given Yearly Yearly One time (for fixed term)
Advantage to Employee Fixed value of options irrespective of company performance. Value benefit drawn from change in the yearly strike price. A lump-sum option feature allows for bigger gains if the company performance improves.
Disadvantage Employee benefits if company loses and vice versa. Loss to employee if price dips. Loss to employee is multiplied due to lump-sum allotment.
Retention Risk Minimal Slightly Higher Highest among the three.
Used by Companies For non-executive employees, focused on low retention risk Who are Post-IPO startups presently having mega-grants. Who are big, stable one’s looking out for fresh innovative blood to take the company forward.

The choice of the plan depends on the type of company as well, and the prevailing market conditions. In general, when joining a company, I would prefer to have a fixed number plan. The basis for the same is from the point that it provides a fixed number whose value can grow if I can get the share price of the company to move up. In addition, there is a scope of mark-up every year through the adjustment of exercise price. It throws a challenge as well, and simultaneously reduces my overall risk if the stock price dips in a particular year due to certain unforeseen circumstances.
On the other hand if the choice is to be made between the stock options and stock grants, I would be inclined towards stock grants. The stock grants allow absolute value gain, minimizing the risk involved. Moreover, the gains through dividends can also be exploited with the grant, and also the benefits of stock options are present in the grants too. Therefore the stock grant has the benefits of options and minimizes the risks of options.
Reference –
Hall, B.J., (2000, March-April). What you need to know about stock options. Harvard Business Review, 78(2), 121-129. Retrieved from www.hbr.org