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Lesson 1. Employee Stock Options > What Is an Employee Stock Option? - Pg. 2

Employee Stock Options 2 The company's goal is to provide an attractive incentive that will help it recruit skilled employees and retain those already on the payroll without using up precious cash in the process. Options can be used to reward performance as well. Employees like stock options because they give employees the opportunity to participate in the growth of the company without any risk. Options are a "free look" for employees. Employees are not required to do anything if the options prove worthless. On the other hand, if the company's stock rises, the employee stands to profit without any of the usual risk associated with an investment. Employees can use profitable options to create an instant cash bonus or build a portfolio for retire- ment or other financial goals. What Is an Employee Stock Option? An employee stock option is the right granted by a company to an employee to buy a specific number of shares of the company's stock at a fixed price during a fixed period. Let's break down this definition to better understand what we are discussing. The first significant term is right, because employee stock options do not obligate you to do anything. Within the guidelines set up by the company, you control what happens, if anything, to the options. You are never required to use the options granted to you. Indeed, as discussed in Lesson 8, "Ex- ercising Your Options," there are times when it is in your best interest to do nothing and let the options expire. The next significant phrase is granted by the company. Employee stock options are an entirely management-driven decision, with the support and approval of the board of directors. For some types of employee stock options, the shareholders must approve the issue. The company is not required to grant stock options and may in fact grant options to some employees, but not to others. The employer has tremendous leeway in granting options, such as only to full-time employees or employees who have been on the job at least two years. As long as the decision is nondiscriminatory (meaning it can't favor men over women or one race over another, for example), the company can structure the plan any way it wants. Caution Law does not require employee stock options. Companies may grant them or not depending on a number of conditions, including profitability or dilution of shares, for example. The law requires employers to offer health insurance and pensions to all employees or none of them. Unlike these benefits, the company can grant employee stock options to whomever it wishes. Companies can grant stock options to nonemployees or other companies, which would make them simply stock options, not employee stock options. For example, in some parts of California where many high-tech companies are created, it is not uncommon for real estate leases to require stock options in the company renting space. Since all leases are negotiable, there is not a standard clause for granting options. However, it is not unheard of for a landlord to require stock options in addition to or instead of a security deposit. The next significant term is buy. If you are familiar with investing terminology, you know that stock options traded on the open market can convey the right to buy or sell the underlying stock. Employee stock options are strictly to buy the company's stock. For example, if you work for XYZ Widget company, its employee stock options are strictly to pur- chase shares of its stock. Options traded on the open market can convey the right to sell shares of XYZ Widget.