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Corporate Uses
Given the ever-increasing cost of executive compensation, stock options are viewed as a way to remain competitive without having to offer cash.
To some degree, companies believe stock options are free to the company. As a result, many companies increase their use of stock options when they are cash poor.
Not all companies agree that stock options provide a great incentive without costing anything.
For example… Big Company has done away with the use of stock options.
The company found that when the stock did well, they were over-rewarding employees vis-à-vis the stockholders. When the stock did poorly, they were undervalued compared to the employees’ efforts.
So, are stock options free to companies? No.
At a minimum, stock options come at a cost to the stockholder. When stock options are exercised, the company issues new stock to cover the call. In the amounts given to top executives, this can significantly dilute the stockholder’s percentage investment. This in turn affects the earnings per share since the earnings are spread out over more shares. Obviously, CFOs don’t want this to happen. So, they buy up stock on the market at the higher current market price, thus hurting the company’s cash position.
In 2004, the Financial Accounting Standards Board (FASB) finalized rules which took effect in mid-2005 imposing the requirement that an explicit expense be recognized by the company in the income statement for stock options going forward, where it was optional in the past.
Memory Jogger
Giving stock options to employees: