EMPLOYEE OPTIONS
Firmsuseequityoptionstorewardmanagersaswellasother
employees.Therearetwoeffectsthattheseoptionshaveon
valuepershare.Oneiscreatedbyoptionsthathavealready
beengranted. Theseoptions, some ofwhich haveexercise
value today,reduce thevalue of equity per share, sincea
portionoftheexistingequityinthefirmhastobesetasideto
meet these eventual option exercises. The other is the
likelihoodthatthesefirmswilluseoptionsonacontinuing
basis to reward employees or to compensate them. These
expected optiongrants reduce theportion of the expected
futurecashflowsthataccruetoexistingstockholdersandthus
thevaluepersharetoday.Inthesubsectionsthatfollow,we
begin by looking at trends in the use of employee stock
optionsandthetypesoffirmswhereoptiongrantsarelargest.
Wealsoexaminethecharacteristicsofemployeeoptionsand
how theyhave been accounted for historically, revisit the
debate on whether employee stock options should be
expensed, and discuss the new accounting rules that will
govern option grants.
Magnitude of the Option Overhang
Theuseofoptionsinmanagementcompensationpackagesis
notnewtofirms.Manyfirmsinthe1970sand1980sinitiated
option-basedcompensationpackagestoinducetopmanagers
tothinkmorelikestockholders.Whatisdifferentaboutthe
more recent option grants, especially at technology firms?
Oneis thatmanagement contracts atthesefirms aremuch
moreheavilyweightedtowardoptionsthanarethoseatother
firms.Thesecondisthatthepaucityofcashatthesefirmshas
meantthatoptionsaregrantednotjusttotopmanagers,but