Employee Stock Option (ESO)

Definition

An Employee Stock Option (ESO) is a type of employee benefit that gives workers the opportunity to buy a certain amount of company shares at a predetermined price. This price is usually lower than the normal market value, offering a potential profit for the employee. ESOs are often used to attract, retain, and motivate employees in a company.

Phonetic

Employee Stock Option (ESO) – /ɪmˈplɔɪ.i stɑːk ˈɑpʃən (iː es oʊ)/

Key Takeaways

1. Employee Compensation tool: ESOs are often used as a part of the compensation package offered to employees. They are means of granting employees the rights to buy a certain amount of company shares at a predetermined price and are used by businesses to retain and attract talented employees.
2. Increases Employee Loyalty and Commitment: Granting stock options to employees is a way to align the interests of the employees and the shareholders. Employees who hold stock options are likely to be more loyal and committed, as they would have a personal interest in the company’s success. It can serve as a powerful incentive for better performance and increased productivity.
3. Vesting Period: Employee stock options often come with a vesting period, a specified length of time during which the employee must remain employed with the company before they have the right to exercise their options and buy shares. The objective is to incentivize employees to stick with the company for a longer term.

Importance

Employee Stock Option (ESO) is important because it is often used as a strategic tool to incentivize, retain, and attract talented employees. ESOs allow employees to purchase shares in the company at a predetermined price offering them potential profits, hence fostering a sense of ownership and aligning their interests with those of the company and its shareholders. Through this, ESOs can stimulate increased productivity, boosting organizational performance and growth. Moreover, ESOs can be a cost-effective form of compensation, as they represent a non-cash expense for the company, balancing employment costs. Therefore, ESOs serve as an essential element in organizational compensation packages, wielding substantial influence over employee motivation and company performance.

Explanation

The purpose of an Employee Stock Option (ESO) is to incentivize employees and align their interests with those of the company’s shareholders. Offering ESOs is a common tactic used by companies to attract, reward, and retain high-achieving employees. They provide employees with the right to purchase a set number of shares in the company at a fixed price, usually lower than the market value, for a specified period of time. As such, if an employee believes in the future success of the company, ESOs serve as a motivational tool encouraging them to contribute towards boosting the company’s performance and, by extension, its share price.Moreover, ESOs are primarily used to bridge the gap between employee’s effort and the financial growth of the company. The intent here is to make employees a part of the company’s success by letting them share in the profits. When an employee’s financial well-being is directly connected to the company’s performance, they are likely to work harder and more efficiently. This not only improves the overall productivity of the company, but also helps cultivate a sense of ownership and loyalty among the workforce. In this way, ESOs also foster a company culture that values long-term commitment and achievement.

Examples

1. Google: Google is a prime example where Employee Stock Options have been used effectively. In the early years of the company, Google offered stock options to its employees. This formed a significant part of their employees’ total compensation packages, and when Google went public in 2004, many of its employees became overnight millionaires due to the appreciation of the stock options they held. 2. Microsoft: Microsoft also famously used Employee Stock Options as a crucial tool to attract and retain top talent. In the 1980s and 90s, Microsoft granted stock options to its employees, which allowed them to buy shares at a fixed price. As the value of Microsoft’s stock soared, these options became extremely valuable, creating thousands of “Microsoft millionaires”. 3. Starbucks: Another real-world example is Starbucks, which through its “Bean Stock” program, offers stock options to both part-time and full-time employees. The program started in 1985 when Howard Schultz, the CEO, wanted to build a company that treats it’s people with dignity and respect. The employees are given the opportunity to share in the financial success of the company through stock options.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Vesting Period: This refers to the length of time an employee must wait to be entitled to fully exercise his/her ESOs.
• Exercise Price: The price at which the ESOs can be executed. The employee will be able to buy the company’s stock at this price.
• Option Agreement: A document that spells out the key details and conditions of the ESO grant, such as the vesting schedule, exercise price, and expiration date.
• Grant Date: The specific date when an employee is given the ESOs. It is typically when the employee can start counting his/her vesting period.
• Expiration Date: The last date an ESO can be exercised. After this date, the options are forfeited if they aren’t used.

Sources for More Information

• Investopedia
• The Motley Fool
• Corporate Finance Institute
• The Balance Careers