Effective employee stock option design: Reconciling stakeholder, strategic, and motivational factors

Executive Overview When markets grew rapidly in the 1990s, many companies unquestioningly adopted employee stock options and implemented them at all levels within organizations. Recently, however, the corporate world has been described as suffering from an “overdose” of stock option compensation. We argue that more attention should be paid to the design of stock options to enhance their effectiveness. In support of this argument, we first review the upsides and downsides of stock options from recipient, company, and shareholder perspectives. Next, we identify conditions in which stock options can help a company implement a strategy and motivate key talent. We then provide guidelines for designing stock options, suggesting that managers must ask the following questions: Who should receive stock options? How many? What terms should be used? How often? At what price? What ownership? Careful consideration of these questions will lead to employee stock option compensation that promotes strategic goals; enables companies to recruit, motivate, and retain employee talent; and satisfies organizational stakeholders. Finally, we highlight some emerging trends that managers must take into account in future stock option designs.