Once reserved only for top management, stock options can now be found in compensation packages for employees at all levels. High technology companies with limited cash and elusive earnings were the first to expand options programs beyond the executive suite, as a way to supplement modest salaries to attract and retain sought after talent.
Stock options grant employees the right to purchase a given amount of company stock at a given price,the strike, or exercise, price,for a given period of time. As stock options do not require the company to make a cash outlay when granted, companies can attract new talent and motivate existing employees without depleting the firmrm's cash. Options allow employees to share in the company's future growth potential, which has been substantial at many technology firms as stock prices soared to new heights.
Today, companies ranging from the Fortune 500 to start-up Internet companies offer options to an estimated seven to 10 million employees. According to a ShareData Solutions survey, the percentage of companies with 5,000 or more employees granting options to all employees rose from 10 to 45 percent in the past three years. Almost three-quarters of companies with less than $50 million in sales offer options to all employees. The National Center for Employee Ownership reports that employees typically own between 5 and 15 percent of public companies, and 20 to 40 percent of privately-held firms. Biotechnology and computer programming companies allocate the most shares to nonmanagers.
A key issue for private companies is setting an appropriate strike price when they issue stock options. The strike price should be equal to the fair market value of the underlying stock at the time each series of options is issued. A strike price that is lower than the market price creates value for the employee that must be recorded on financial statements as additional compensation expense, reducing earnings. For a public company, per-share values are published in a number of places; however, such is not the case for private companies.
One of the more popular forums for private company valuation, in connection with stock options, is the initial public offering process. Because the SEC scrutinizes a company's pre-IPO financial statements, companies should not rely on intuitive, "rule of thumb' equity valuations. If the SEC believes there is too great a disparity between prior stock option strike prices and the equity valuation at the time of issuance, it will likely require the company to restate its financial statements to account for the additional compensation.
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