Benefits and disadvantages of employee stock options and share ownership

Employee stock options usually cost less than market price

Issuing shares to employees of corporations can be achieved through a number of methods including stock options, employee stock ownership plans (ESOPs) or employee stock purchasing plans (ESPP).

Each form of share offering has unique advantages and disadvantages, several of which they have in common. When companies offer employees shares, the net benefit or disadvantage to that corporation is often carefully weighed before taking the decision to carry out such an  endeavor.

Advantages

Tax deductibility

A number of corporate benefits arise out of employee stock ownership plans. Specifically, tax benefits  including either tax deferral or tax exemption. For example, according to the National Center for Employee Ownership (NCEO), a large C-corporation that sells 30 percent of its shares to employees can defer tax on gains from the reinvested proceeds; and in the case of smaller S-corporations, 30 percent of total corporate income is tax exempt from federal taxation. 

Conserves cash

Additional advantages exist to offering employees shares of a corporation through stock option programs. For example, according to the Congressional Budget Office (CBO), stock options help minimize compensation costs. Moreover, when stock options are valued using an accounting method known as intrinsic valuation, the stock options do not have to be recorded as an expense, thereby keeping earnings numbers higher.

Improves performance

Offering stock to employees can also assist in retaining quality employees, and developing corporate pride per the Edward Lowe Foundation. Furthermore, when employees are also substantially vested owners of a corporation, their performance becomes more closely linked to the share price of a corporation. For instance, if stock options have a purchase price above current market prices, then in order to make a profit from those stock options, the price will have to rise in the future and possibly affect work output, quality and production in a positive way.

Disadvantages

Stock dilution

In addition to the cost of establishing an employee share ownership program, stock dilution can cause equity capitalization to drop. Moreover, if an issuance of stock to a stock options plan  is too large, the diluted earnings per share for the company can become substantially lower. This can negatively impact cash-flow per the Menke Group. This in turn can compound managerial incentive issues, cash flow and financing costs.

Managerial complications

Another substantial disadvantage of issuing shares to employees is the price can drop and potentially create managerial issues per Inc. Magazine. Moreover, since one of the reasons for offering stock ownership choices to employees is to boost morale and improve corporate culture, employees of that company also become more exposed to market or economic events that could have a negative affect on motivation and production. A similar affect may occur if the stock options are not viewed as substantial or if the performance expectations for both the corporation and employees is unrealistic.

Limited availability

Depending on the particular plan used by a corporation, offering shares to employees can be limited to full-time employees only per the NCEO. Furthermore, ESOPs are not available to partnerships and many professional businesses according to the NCEO. Unless a corporation is in the practice of only hiring full-time employees, or has a structure that allows ESOPs, a benefits gap may reduce the effectiveness of the stock offering to increase production and ownership related objectives.

Image: Dave Dugdale, CC BY-SA 2.0
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