Employee Stock Options
1
EMPLOYEE STOCK
OPTIONS
Employee Stock Option Plans/Equity Incentive Plans (commonly referred to
as ESOPs) are one of the most important tools to attract, encourage and
retain Employees. It is the mechanism by which employees are
compensated with increasing equity interests over time.
Company grants an option to its Employee to acquire Equity Shares of the
company at a future date and at predetermined price.
There is no limit on quantum of ESOPs to be issued to employees
Owners STOCKS Employees
WHY ESOPs?
Attract, Reward, Motivate and Retain
Employees
Enhances job satisfaction
Deferred compensation strategy
Good retirement benefit plan
Employee aligns with company’s goals
RESTRUCTURING MODES
UNDER ESOP
Employee Employee
Stock Option Restricted
Stock
Plans Stock Units
Purchase Plan
(ESOP) (RSU)
(ESPP)
Stock Stock
Appreciation Appreciation
Rights – Cash Rights – Equity
Settled Settled
(SAR-Cash (SAR-Equity
Settled) Settled)
MAJOR TERMS TO
UNDERSTAND
Grant: Offering of ESOP Options from Company to
Employee
Vesting: Process through which employee becomes eligible
to exercise options
Exercise: When employee applies to Company for getting
shares allotted
EMPLOYEE STOCK OPTION
PLAN
It (ESOP)
is a right offered by a company to its employees to take equity
shares of company at discounted price.
Grant of Vesting of Exercise of
Allotment
options options Vested
of Shares
options
Example of Companies Offering ESOPs:
EMPLOYEE STOCK
PURCHASE
It PLANS
allows Employee to purchase (ESPP)
Company’s shares, often at a
discount from Fair Market Value.
Offer of
If accepted by the Allotme
shares at
Employee nt of
discounte
d price shares
Example of Companies Offering ESPPs:
RESTRICTED STOCK
UNITS (RSU)
Employee is awarded with the shares subject to fulfillment of certain
underlying conditions.
Grant Exercise
Vesting Allotm
of of
of ent of
option Vested
options shares
s options
Underlying If Condition fulfilled
Conditions like:
- Target / Revenue
- Performance
based etc.
Example of Companies Offering RSUs:
STOCK APPRECIATION
RIGHTS (SAR)
In case of SARs employee gets the benefit in the form of cash /
equity which is the difference between the date of grant and final
exercise of options.
Grant of Exercise
Vesting of of Vested
Options
Options Options
Share price on
Share price on
Grant Rs 10
Exercise Rs 100
Shares
Appreciation = Rs. 90/-
Cash
Example of Companies Offering SARs:
Nature of Employee Stock Options
• Employee stock options are call options
issued by a company on its own stock
• They are often at-the-money at the time
of issue
• They often last as long as 10 years
10
Typical Features of Employee Stock Options
• There is a vesting period during which options
cannot be exercised
• When employees leave during the vesting period
options are forfeited
• When employees leave after the vesting period in-
the-money options are exercised immediately and
out of the money options are forfeited
• Employees are not permitted to sell options
• When options are exercised the company issues
new shares
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Exercise Decision
• To realize cash from an employee stock option
the employee must exercise the options and
sell the underlying shares
• Even when the underlying stock pays no
dividend an employee stock option (unlike a
regular call option) is often exercised early
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Drawbacks of Employee Stock Options
• Gain to executives from good performance is much
greater than the penalty for bad performance
• Executives do very well when the stock market as a
whole goes up, even if their firm does relatively poorly
• Executives are encouraged to focus on short-term
performance at the expense of long-term performance
• Executives are tempted to time announcements or take
other decisions that maximize the value of the options
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ESOP IMPLEMENTING
MODES
Direct
Route Trust
Route
DIRECT ROUTE
Direct
Route
1 Options to buy
shares
Compa 2 Exercise of options Employ
ny 3 Issue of shares
ee
TRUST ROUTE Trust
Route
1
4
Grant of Loan for
Payment of subscription
Employe Exercise of options
Money e Welfare
Trust
6 5
Repayment Transfer of
of Loan Shares
Compan Employe
y 2 Direct Issue of Shares
e
3 Issue of options
WHAT COMPANY’S SEE WHILE
GRANTING ESOPs
Loyalty
Performance
Designation
Present & Potential Contribution
Opportunity Cost
