Employee Stock Option - ESO

What Does Employee Stock Option - ESO Mean?

A stock option granted to specified employees of a company. ESOs carry the right, but not the
obligation, to buy a certain amount of shares in the company at a predetermined price. An
employee stock option is slightly different from a regular exchange-traded option because it is
not generally traded on an exchange, and there is no put component. Furthermore,
employees typically must wait a specified vesting period before being allowed to exercise the
option.

Investopedia explains Employee Stock Option - ESO

The idea behind stock options is to align incentives between the employees and shareholders of a
company. Shareholders want to see the stock appreciate, so rewarding employees when the stock
goes up ensures, in theory, that everyone is striving for the same goals. Critics point out,
however, that there is a big difference between an option and the ownership of the underlying
stock. If the stock goes down, the holder of an option would lose the opportunity for a bonus, but
wouldn't feel the same pain as the owner of the stock. This is especially true with employee stock
options because they are often granted without any cash outlay from the employee.

Another problem with employee stock options is the debate over how to value them and the
extent to which they are an expense on the income statement. This is an ongoing issue in the U.S.
and most countries in the developed world.
Filed Under: Acronyms, Options, Stocks
Related Terms

What Are the Advantages of Employee Stock

Options?
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During the heyday of the Internet, in the late 1990s, stock options were the major drawing card,
or big-ticket item, that brought major talent to many new up-and-coming high-tech companies.
By offering a part of the future growth and a percentage of the great wealth the company would
generate, rather than greater compensation, newly emerging companies were able to hold onto
their cash to spend wisely. Unfortunately many did not do so and the companies foundered. This
left many young executives holding worthless options.
Today, stock options are still part of the packages offered by many companies. However, they
are typically added perks and do not serve as a replacement for a competitive salary. In addition,
they are not as commonly offered by young emerging companies.

The stock option gives you, as an employee, the opportunity to buy a specified number of shares
in a company for a certain number of years. The offering price, called the grant price, is typically
the market price at the time the option is offered. The benefit is that the employee can exercise
the option when he or she wants to within a set period of time. If the stock has gone up, he or she
can purchase the shares at the original grant price and then either sell them for a profit or hold
onto the shares in hope the stock will continue to gain.

By way of an example, a typical stock option grants:

 10,000 shares
 Exercisable at 50 cents per share
 Vesting over a 4-year period
 Exercisable until a designated date.

There are two types of stock options, incentive (or qualified) stock options and non-qualified
stock options.

Employee Stock Option: Tax Treatment and

Advantages
by: sahil | last updated: March 29, 2010
Category: Personal Finance | Tags: employee stock options, stocks, employee benefits, call option,
employee plans, workers benefits, employment plans

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Employee Stock Option is a call option available to an employee which is a stock option issued
as a type of non-cash compensation. A call option is nothing but the option open for a person to
buy shares of stocks at a specified time in the future. The benefit for the company that provides
such an option is that if the performance of the company rises; so does its stock and the
employee receives direct financial benefit by helping in achieving a higher amount of
productivity.

This simply means that the employee stock option provides workers with an incentive to work in ways
that will improve the company’s stock price. Employee stock options are typically accessible to
management as a component of their executive compensation package. They could also be accessible to
non-executive level employees, particularly by businesses that are not yet gainful, as they might have
hardly any other means of compensation.

On the other hand, employee-type stock options can be given to non-employees: promoters, lawyers,
consultants, and suppliers for services provided. Employee stock options can be comparable to
warrants, which are call options given by a company with regard to its own stock. There are many
differences between an employee stock option and standard exchange traded options. These include
changes in the exercise price, quantity, vesting, duration, the non-transferable factor, and taxation
issues.

According to US generally accepted accounting principles in effect before June 2005, stock options
granted to employees did not require to be acknowledged as an expense on the income statement
when granted, even though the cost was revealed in the notes to the financial statements. This permits
a potentially hefty form of employee compensation to not show up as expenditure in the existing year,
and consequently, presently exaggerate revenue. Numerous experts emphasize that over-reporting of
income by techniques such as this by American corporations was one causative factor in the Stock
Market recession of 2002.

Employee stock options must be expensed under US GAAP in the United States. Every company must
start expensing stock options no later than the first reporting period of a fiscal year starting after June
15, 2005. As the majority companies have fiscal years that are calendars, for nearly all companies this
means starting with the first quarter of 2006. Consequently, companies that have not willingly started
expensing options will only see an income statement outcome in fiscal year 2006.

 
There are numerous types of stock options offered to people in the United States and differ in their tax
treatment. These are Incentive stock options, Put options, and Non-qualified stock options. The tax
treatment of these depends on whether a taxable event has occurred when the option was granted to
the employee.

In the United States, according to the IRS (Internal Revenue Service), no taxable event occurs when the
option is granted. However, the employee may or may not be taxed on the exercise of such option. For
instance, Non-qualified stock options are taxed upon exercise; however Incentive stock options (ISO) are
not, presuming that the worker complies with certain supplementary tax code requirements.

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How You Can Benefit From An Employee Stock Option Plan

Employee stock option plans are becoming increasingly common as companies compete for
quality workers. At a time when there is an increasing trend for people to move from one job to
another, far more than there ever used to be, companies are finding a need to come up with an
incentive to keep good workers within their own organization. One possible way of doing this is
to provide incentives which will grow in value the longer the worker stays with the company.
The system is not without flaws, both from the point of view of the employer and the employee,
but it has plenty of good points.

The basic idea of employee stock options is that they allow a worker to buy shares in the
company, at a predetermined level. This is obviously a major incentive for a good worker to
choose that particular company, as there is plenty of potential for the price to rise, locking in a
risk-free profit. Of course, this does not always happen, but inflation will usually ensure that a
company's share price will rise in time unless something goes fundamentally wrong.

If the share price does not rise, neither the company nor the employee has actually lost anything,
because all the employee had was an option. There were never any shares changing hands. The
option to buy at a certain price is obviously never going to be taken up if the price remains lower
than that option price. The company will not gain any benefit from an increased demand for the
shares, but they also will lose nothing.

If a worker has employee stock options, then there are several things they can do convert this
opportunity into money. The first and most obvious is simply to wait until the share has risen in
value, and then buy and quickly sell on again in the open market. This way, you are guaranteed
to make a profit, although there is of course no guarantee that you could not have made a far
greater one had you held the shares for longer. There is obviously risk involved in any choice
you make as to when you actually sell the shares.

You can also try to profit from your employee stock option allocation by buying to hold. If the
price has gone higher when you buy at the option rate, you can just set a stop loss point at which
you will sell the shares to get out with a small profit in case the price reverses, and then wait and
see what happens. If the price stays above the stop loss level you have set, you will continue to
collect annual dividends on your investment. You can keep moving the stop loss point higher to
lock in more profits, meaning you are guaranteed to benefit handsomely from your employee
stock option

. An employee stock option is the right granted by an employer to buy, or "exercise" a

given number of shares of company stock at a predetermined price, which is known as the
"grant," "share," or "exercise" price. The option is open over a set period of time, known as the
"exercise period." The "strike" price is usually the market value of the shares at the time the
option is offered, but this is not always true. The profit for employees is realized if they can sell
the stock for more than they paid during the "exercise" period.

An option in which the underlie is the common stock of a corporation,

giving the holder the right to buy or sell its stock, at a specified price, by a specific date. Also
called equity option. The right, but not the obligation, to buy (for a call option) or sell (for a put
option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified
price (the strike price) during a specified period of time.

An option, as a call or put, to buy