by An employee stock option (ESO) is a label that refers to compensation contracts between an employer and an employee that carries some characteristics of financial options.
Employee stock options are commonly viewed as a complex call option on the common stock of a company, granted by the company to an employee as part of the employee’s remuneration package. Regulators and economists have since specified that ESOs are compensation contracts.
These nonstandard contracts exist between employee and employer, whereby the employer has the liability of delivering a certain number of shares of the employer stock, when and if the employee stock options are exercised by the employee. The contract length varies, and often carries terms that may change depending on the employer and the current employment status of the employee. In the United States, the terms are detailed within an employer’s “Stock Option Agreement for Incentive Equity Plan”. Essentially, this is an agreement which grants the employee eligibility to purchase a limited amount of stock at a predetermined price. The resulting shares that are granted are typically restricted stock. There is no obligation for the employee to exercise the option, in which case the option will lapse.
ESOPs were given to remunerate senior employees and to acknowledge their proven contribution to the company. However, in modern times, ESOPs are used as compensation and motivational tool as startups can’t afford to spend high salaries in the beginning stage. Employee Stock Options in India has gained immense popularity in the recent times with the emergence of a vibrant startup ecosystem in the country.
Stories of how Infosys, one of the earliest companies to offer ESOPs, created millionaires of employees such as drivers, are very well known.
Employee Stock Option Plans are the plans in which employees get the right to purchase a number of shares (decided by the employer) in lieu of Salary in the company at a discounted price (less than the market price). The option provided under this scheme confers a right but not an obligation on the employee.
Employees have to wait for a certain time period – known as vesting period – before they can exercise the right to purchase those specified number of shares. Upon vesting of options, employees can exercise the options to get shares by paying the pre-determined exercise price.
ESOPs are generally awarded for performance or tenure of the employee with the company. Thus, it serves a two-fold purpose for both the company and the employees.
- It acts as a tool of motivation for the employees that once they own a stock they feel responsible for performance of the company, as it determines the value of the stocks of the company.
- It helps the employer to retain the company and assure a good level of performance in the work.
Advantages of esop
- ESOPs can be treated as a retainership instrument for small businesses as there is a lock in period for exercising the right to purchase the shares. Thus, a business can retain its employees. If an employee opts for this option then he has to serve the lock in period to become eligible to exercise it.
- Getting shares of the company in which they are working gives employees an ownership feeling. They start feeling that they are not employees of the organisation but owners. Also, they get to share the profits of the company in the form of dividends and are motivated to work for the best of the company.
- Businesses that needs funds and are not in a position to spend hefty amounts can offer this option to their employees in lieu of salary and motivate them to work for the betterment of the company.
- It is a non-cash compensation tool to compete for the best human resources.
- It gives an opportunity to corporate to pay without a reduction in book profits.
- Boosted Morale of Employees.
Disadvantages of esop
- When the ESOPs are exercised the founders share holding gets diluted.
- Since, Company is unlisted Company, there are no marketability or liquidity of shares of private company. Hence, there are chances of disputes between employers and employees when employee leaves the organization.
- There are also chances of disputes while transfer of shares and the value at which shares should be transferred.
