Employee Stock Option Plan (ESOP) – Defined
An employee stock option plan is an employer-employee plan or agreement whereby the employee earns or is awarded the right buy a specific amount of the company’s stock shares at a specified rate. The option to purchase must generally be exercised within a specified period of time.
A Little More About Employee Stock Option Plans
Employee stock options are a method for employers to incentivize and retain employees. New employees may need to wait a specified period of time before being allowed to take part in an employer’s ESOP.
The grant of stock options can come as a contractual salary benefit. Otherwise, employees can contribute to ESOP in the form of payroll deduction. The “strike price” or exercise price for the option is generally the fair market value of the shares at the time of grant. This means that the options only have monetary value if the value of the purchasable shares rises. This also means that the employee is not taxed for receiving the stock option at the time it is granted.
The ESOP incentivizes employees by providing them a stake in the company’s success. Let’s assume that the company grants stock options to an employee. The plan allows an employee to buy 500 shares at the strike price of $10 per share. The options vest (are owned by the employee) after two years.
Now, assume the prices of shares jump up from $10 to $15 after the grant. Employees can exercise stock option to acquire the 500 shares for $5,000. They can then sell them into the market, back to the company, or to other shareholders for for $7,500. In this way they make $5 gain per share or total of $2,500 gain.
Instead, if the prices did not increase then the employee has no obligation to purchase the share. She will simply let it expire. As noted earlier, the stock option must generally be exercised within a specified period of time.
References for Employee Stock Option Plans