Options for Executives
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Why do companies issue options to executives if they cost the company more than they are worth to the executive? Examples please.
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Solution Summary
This solution explains why companies issue options even when the cost incurred is more than the value to executives.
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Employee Stock Option Plan, is a mechanism by which employees of a particular company are entitled to buy, at a 'fair' value, the stock of the company they work for. Thus it is an option to buy the company's share at a certain price. This price which could be the market price or some other price. Normally, to make an ESOP attractive, the option price is lower than the market price.
The option to acquire shares is generally exercisable over a period of time, known as vesting period (generally ranging from 1 to 5 years). Since options lapse if the employee leaves employment before the vesting period is over, ESOPs work as an incentive for the employee to stick around for that time
ESOPs are a good motivation tools. Company faces the problem of conflict of interest between the organization and management. In theory stockholders are expected to exercise control over managers through the annual meeting or the board of directors. In practice, these disciplinary mechanisms not work. It means that management may not work for maximization of wealth due to following reasons:
1. Lack of Motivation
2. ...
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