Get access to HR news and resources that you can trust. Is your employee handbook performance for the changing world of work? Expand your influence and learn how to become an effective leader -- Join us in Phoenix, AZ, October Stock options as performance incentives have been on a roller coaster ride for decades.
They were the quintessential get-rich-quick enticement used by tech startups during the dot-com boom in the late s, but their star later dimmed amid allegations of abuse by unethical companies. Many executive compensation consultants say stock options are still a valuable tool—as long as employers know how and when to use them. If anything, stock options may be undervalued as a performance incentive tool, particularly as part of a long-term package.
With restricted stock, the company promises to pay shares of stock in the future based on performance or time-based vesting, without a requirement that the employee performance for them. These are not awards of actual stock, but rather a promise to pay a cash bonus equivalent to the value options company shares. Similar to phantom stock, these rights award the appreciation in the value of a certain number of shares over a given period of time.
Stock options involve awarding employees an option to purchase stock at a set price, known as the strike price or the exercise price, for a certain number of years. The strike price is stock the value of the underlying stock determined on the date stock option is granted, and employees have the right to acquire the stock after the shares are vested, typically over a three- to four-year period. Employees are economically motivated to exercise the performance if the current stock price is above the strike price.
The typical exercise period, also called the option term, is 10 years from the grant date, which theoretically allows enough time for the stock price to recover from a down market.
The most common type of stock options, these are taxed when they are exercised. Taxation for these options can be deferred until the acquired stock is sold, and it occurs at more-favorable capital gain rates.
However, incentive stock options are subject to a variety of additional regulations and restrictions. For one thing, they can be awarded only to employees and are not available to board members or independent contractors. Finally, recipients are required to hold option-generated stock for at least one year after the exercise date and for two years after the grant date in order to obtain favorable tax treatment.
Using independent valuation or appraisal. This involves having an independent firm evaluate the value of the options every year. For example, the formula may be tied to earnings before interest, taxes, depreciation or amortization. Conversely, in industries with high growth rates, such as certain tech fields, options can be a lucrative incentive. However, if the intent is performance attract employees and motivate loyalty by giving them a stake in the company, the conditional nature of the options could make them less effective than some other long-term incentives that involve the award of and stock.
There is also the possibility that, if the stocks do pay off handsomely, employees may become independently wealthy firm leave the company. There are a number of reasons for stock. Many people came to associate stock options with fraud and abuse in the mids, after they were liberally used by Enron and other companies.
A lack of growth further diminished their appeal. According to the CEO Pay Strategies Report by consultancy Equilar Where are stock options today? As ofan estimated 9 million employees in the U. High-growth industry sectors, such as biotech and technology, are more likely to offer options. They tend to be more common in public companies that can more easily establish stock value, notes Steve Parrish, national advanced solutions director at Principal Financial Group in Des Moines, Iowa.
Starbucks and Southwest Airlines are two examples. The largest number of stock options are and to individuals who can affect the fortune of the company, and at larger companies in particular, Parrish says.
Experts encourage private employers thinking about using stock options to options themselves the following questions: They are also common among startups. Consider the November IPO of social media giant Twitter. Many companies tend to offer restricted stock to performance employees; a mixture of 50 percent time-vested restricted stock and 50 percent performance-based shares to more-senior-level employees; and a mixture of stock options, performance-based shares and time-vested restricted shares to the most-senior executives.
Should you grant stock options broadly or target them to senior management? There are pros and cons to each approach. On the other hand, in some industries and in some geographic locations, it is likely that lower-paid employees would rather have extra cash, which is easier stock understand and to spend. The timing of stock option awards varies. Most companies award stock options annually as part of total target compensation, and many tech companies give them throughout the year.
To compete for talent, some employers offer stock options at the time of hire. The amount of stock to provide employees is also a key question. The point is how firm align the incentive with what will motivate them. What percentage of base pay [do you want it to be]?
It will be different percentages for different companies. Options October report from UBS Wealth Management Americas found that 60 percent of employees do not place significant value on equity awards.
The survey identified three actions companies can take to involve employees and drive engagement around equity compensation plans:. Drive a strong culture. Ensure that options plan design is straightforward. If employees can easily understand the plan, they are more likely to grasp the value of the awards.
The UBS and found that stock options were viewed by employees as one of the more complicated performance incentives, second only to performance shares.
And offering clear communication and support will help make them an even firm option. David Tobenkin is a freelance writer based in the Washington, D. You may be trying to access this site from a secured browser on the server. Please enable scripts and reload this page.
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Job Finder Find an HR Job Near You. LOCAL CHAPTERS Find chapters in your area. HR Magazine Do Stock Options Work as an Employee Incentive? By David Tobenkin Mar 1, Checklist for Private Employers Experts encourage private employers thinking about using stock options to ask themselves the following questions: Will it harm the salability of privately held businesses by complicating minority shareholder interests in the company?
What accounting will be needed to book the value of the stock options and the taxation of discounted stock options? Can having too many shareholders convert the business into a public company under U. This is a clear danger for small companies, as they will become subject to more-onerous public financial disclosure requirements. Will shareholders need to approve stock option plans, including details such as classes of employees and others eligible for the options?
What about the number of shares of company stock reserved for issuance under the plan? Do employers have the right to repurchase shares if an options holder leaves the company? What is the vesting treatment of stock and if the company undergoes a change in control? Employee Stock Plans Provide k Loan Alternative SHRM article: What Are the Benefits of and Requirements for Establishing a Stock Option Incentive Plan?
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