The Problems With Stock Options As Employee Compensation

Some employers decide to offer their employees the incentive of stock options as a form of employee compensation, and while this may seem like a good option at first glance, there are actually quite a few issues with it. Find out why employers might choose employee stock options as incentives and why they probably shouldn’t.

The Pros of Employee Stock Options

There are a number of benefits of offering employee stock options. However, it’s important to keep in mind that these may not outweigh the consequences of offering them. Check out some of the benefits of employee stock options here.

Employee Tax Flexibility

Stock options offer employees tax flexibility, as they can choose when they exercise their stock options and, thus, the time when they are liable for income taxes associated with investing in these stock options.

An Affordable Incentive

When companies are looking for incentives for their employees, they will most likely gravitate towards their most affordable choices, and employee stock options are often the most affordable of them all. After all, all the employer is doing is offering stock in their company at a reduced price, and offering employee stock options may even gain the employer tax benefits and eligibility for tax exemptions or deferments depending on the legal status and size of the company.

Increased Employee Confidence

If employees feel as though they are working towards a goal of some sort, they tend to work more productively and be happier employees overall. Employee stock options help keep a company’s employees determined to succeed and boost their overall confidence.

The Cons of Employee Stock Options

There are a number of problems associated with offering employee stock options that may overshadow their benefits. Here are a few of the problems that can arise when a company decides to offer employee stock options as incentives.

Stock Dilution Dangers

When an employer decides to offer employee stock options, they often run into the unfortunate problem that they do not have enough of their shares to satisfy the needs. To deal with this, the company will often issue additional shares which lead to stock dilution. This can cause disruptions in both equity capitalization and cash flow that can greatly affect the company. They may even experience shifts in voting control, earnings, and stock position due to stock dilution.

Problems with Irresponsible Investments

It is important to keep in mind that the majority of your employees likely are not responsible investors. These investors, although with likely good intentions, may not understand just how important it is to diversify your investments. Oftentimes, employees offered stock options will buy as much stock in the company that they can afford not realizing that the stock may decline in value.

Harm to Planning Efforts

Offering employee stock options may cause issues in your company’s planning efforts. For example, if you are considering selling your company, you will likely want to keep your market examination private. Buyers are also often wary of pursuing companies that have many minority shareholders and smaller stock options.

Related: When Should You Sell Your ESPP

DISCLOSURE: Please note that I may have a position in one or many of the holdings listed. For a complete list of my holdings, please see my Dividend Portfolio.

DISCLAIMER: Please note that this blog post represents my opinion and not an advice/recommendation. I am not a financial adviser, I am not qualified to give financial advice. Before you buy any stocks/funds consult with a qualified financial planner. Make your investment decisions at your own risk – see my full disclaimer for more details.
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