Employee stock options book

Employee Stock Options Fact Sheet.

What Is a Stock Option?

Stock Options and Employee Ownership.

Practical Considerations.

Stay Informed.

Our twice-monthly Employee Ownership Update keeps you on top of the news in this field, from legal developments to breaking research.

Related Publications.

You might be interested in our publications on this topic area; see, for example:

GPS: Participant Education and Communication: Case Studies.

Discusses the strategic and practical issues of participant communication in a variety of types of equity plans, from ESPPs to options.

The Stock Options Book.

A comprehensive guide to employee stock options, with extensive technical details.

GPS: Global Stock Plans.

Discusses issues such as grant processes, transactions, and taxes for public companies that grant equity compensation outside the U. S.

Performance-Based Equity Compensation.

Provides the insight needed to create and manage a successful performance equity program.

Private Company Equity Compensation Administration Toolkit.

Checklists and templates to help private companies manage equity plans and delegate tasks.

Accounting for Equity Compensation.

A guide to accounting for stock options, ESPPs, SARs, restricted stock, and other such plans.

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Link to Us.

NCEO Membership Brochure.

Read our membership brochure (PDF) and pass it on to anyone interested in employee ownership.

The Stock Options Book.

18th Edition.

by Alison Wright, Alisa J. Baker, and Pam Chernoff.

This is the print version, and shipping charges apply. It also is available in a digital version with no shipping charges.

$35.00 for NCEO members; $50.00 for nonmembers.

A 20% quantity discount will be applied if you are a member (or join now) and order 10 or more of this publication. If you need to order more than the maximum number in the drop-down list below, change the quantity once you have added it to your shopping cart.

- Tim Sparks, President, Compensia, Inc.

- Robert H. (Buff) Miller, Cooley Godward Kronish LLP.

Publication Details.

Format: Perfect-bound book, 392 pages.

Dimensions: 6 x 9 inches.

Edition: 18th (March 2017)

Status: In stock.

PDF of the book's comprehensive table of contents.

Part I: Overview of Stock Options and Related Plans.

Chapter 1: The Basics of Stock Options.

Chapter 2: Tax Treatment of Nonstatutory Stock Options.

Chapter 3: Tax Treatment of Incentive Stock Options.

Chapter 4: Plan Design and Administration.

Chapter 5: Employee Stock Purchase Plans.

Chapter 6: Trends in Equity Compensation: An Overview.

Part II: Technical Issues.

Chapter 7: Financing the Purchase of Stock Options.

Chapter 8: Overview of Securities Law Issues.

Chapter 9: Tax Law Compliance Issues.

Chapter 10: Basic Accounting Issues.

Chapter 11: Tax Treatment of Options on Death and Divorce.

Chapter 12: Post-Termination Option Issues.

Part III: Current Issues.

Chapter 13: Legislative and Regulatory Initiatives Related to Stock Options: History and Status.

Chapter 14: Option Backdating: Timing of Option Grants.

Chapter 15: Cases Affecting Equity Compensation.

Chapter 16: Transferable Options.

Chapter 17: Reloads, Evergreens, Repricings, and Exchanges.

Appendix 1: Designing a Broad-Based Stock Option Plan.

Appendix 2: Primary Sources.

From Chapter 3, "Tax Treatment of Incentive Stock Options" (footnotes omitted)

From Chapter 10, "Basic Accounting Issues"

From Chapter 16, "Reloads, Evergreens, Repricings, and Exchanges" (footnotes omitted)

However, the issuer must still satisfy a number of hurdles to effect a valid exchange offer, including providing certain financial materials to both employees and the SEC, making various SEC filings, holding analyst calls (where appropriate), and providing a withdrawal period of at least 20 business days to offerees.

Other NCEO Publications on Equity Compensation.

You may be interested in our other publications in this field; see, for example:

GPS: Global Stock Plans.

Discusses issues such as grant processes, transactions, and taxes for public companies that grant equity compensation outside the U. S.

Private Company Equity Compensation Administration Toolkit.

Checklists and templates to help private companies manage equity plans and delegate tasks.

The Decision-Maker's Guide to Equity Compensation.

How to find and implement an equity compensation strategy that works for your company.

GPS: Restricted Stock and Restricted Stock Units.

Discusses regulatory and administrative issues for public companies that grant restricted stock and restricted stock units.

Stay Informed.

Our twice-monthly Employee Ownership Update keeps you on top of the news in this field, from legal developments to breaking research.

Share This Page.

Link to Us.

NCEO Membership Brochure.

Read our membership brochure (PDF) and pass it on to anyone interested in employee ownership.

Employee Stock Option - ESO.

What is an 'Employee Stock Option - ESO'

An employee stock option (ESO) is a stock option granted to specified employees of a company. ESOs offer the options holder the right to buy a certain amount of company shares at a predetermined price for a specific period of time. An employee stock option is slightly different from an exchange-traded option, because it is not traded between investors on an exchange.

BREAKING DOWN 'Employee Stock Option - ESO'

How a Stock Option Agreement Works.

Assume that a manager is granted stock options, and the option agreement allows the manager to purchase 1,000 shares of company stock at a strike price, or exercise price, of $50 per share. 500 shares of the total vest after two years, and the remaining 500 shares vest at the end of three years. Vesting refers to the employee gaining ownership over the options, and vesting motivates the worker to stay with the firm until the options vest.

Examples of Stock Option Exercising.

Using the same example, assume that the stock price increases to $70 after two years, which is above the exercise price for the stock options. The manager can exercise by purchasing the 500 shares that are vested at $50, and selling those shares at the market price of $70. The transaction generates a $20 per share gain, or $10,000 in total. The firm retains an experienced manager for two additional years, and the employee profits from the stock option exercise. If, instead, the stock price is not above the $50 exercise price, the manager does not exercise the stock options. Since the employee owns the options for 500 shares after two years, the manager may be able to leave the firm and retain the stock options until the options expire. This arrangement gives the manager the opportunity to profit from a stock price increase down the road.

Factoring in Company Expenses.

ESOs are often granted without any cash outlay requirement from the employee. If the exercise price is $50 per share and the market price is $70, for example, the company may simply pay the employee the difference between the two prices multiplied by the number of stock option shares. If 500 shares are vested, the amount paid to the employee is ($20 X 500 shares), or $10,000. This eliminates that need for the worker to purchase the shares before the stock is sold, and this structure makes the options more valuable. ESOs are an expense to the employer, and the cost of issuing the stock options is posted to the company's income statement.

Stock Compensation Plans Compared and Contrasted.

The current economy has offered an opportunity to review the advantages and disadvantages, as well as the book and tax treatments, of the various types of stock compensation that banks use to compensate and incentivize executives. These include incentive stock options (ISOs), non-qualified stock options (NQSOs), restricted stock and phantom stock. The status of the economy and resulting bank stock values may cause one type of stock compensation to be more attractive and manageable than another type, thus the opportunity for review. We will discuss each type separately.

Incentive Stock Options (ISOs)

ISOs will confer beneficial tax treatment to the employee in the form of trading current compensation at ordinary tax rates for future capital gains. The employee doesn’t recognize income until the shares are sold, thus the employee should come out ahead on gains realized upon sale (assuming capital gain rates stay lower than ordinary rates). The amount of capital gain will be the difference between the sales price and the option price paid.

In general, ISOs must meet the following IRS prescribed requirements:

The option price must not be less than the fair market value of the stock on the date of grant and must be exercisable with ten years from date of grant. The employee cannot own stock with more than 10% of the total combined voting power of all voting shares. The employee must be an employee from the time the option is granted until three months before the option is exercised. The employee cannot dispose of the stock resulting from the exercise of the options within two years of the date of grant.

The employee must hold the stock for at least one year after exercise. If the stock is sold within the required one-year holding period, a ‘disqualifying disposition’ results and the gain on the sale is treated as compensation rather than capital gain (although will not be subject to income or employment tax withholding if the options were exercised after October 22, 2004).

Book Treatment – Generally, when ISOs are granted, compensation expense is booked in an amount equal to the fair value of the option on date of grant times the number of vested options granted (nonvested options will book as compensation as they actually vest or performance occurs). At the date of exercise, common stock and APIC are credited. Tax Treatment – For tax purposes, ISOs when granted are not compensation to the employee; therefore, no tax deduction is allowed for the amount of compensation deducted on the books. This normally results in a permanent book-tax difference. However, should the employee sell the stock before the one-year holding period is up, the result will be compensation income to the employee. The bank will be allowed a corresponding compensation deduction.

Non-Qualified Stock Options.

Non-qualified stock options (NQSOs) are stock options that do not meet the above requirements to be an ISO. As opposed to ISO’s, they will have elements of both compensation income and capital gain income (could be short - or long-term) to the employee.

Book Treatment – Same as for ISOs. Tax Treatment – In contrast to ISOs, NQSOs are taxable upon grant as long as the stock has a readily ascertainable fair market value (defined very specifically in the Code). Because the value of most community bank stock won’t meet the narrow definition of ‘readily ascertainable’, bank NQSOs are generally taxed to the employee upon exercise. The amount of income is the difference between the fair market value of the stock and the exercise price the employee paid for it. The bank would get a corresponding compensation deduction. Short-term or long-term capital gain results when the shares are sold, depending upon the holding period, which begins the day after exercise.

Since both the book and tax treatment will result in a compensation deduction, only at different points in time, a timing difference results affecting the deferred tax calculation (unlike ISOs sold after the one-year holding period).

Restricted Stock.

Restricted stock is different from ISOs and NQSOs in that actual stock is awarded, not just an option to buy stock; however, there are restrictions on the stock relating to the recipient’s ability to fully own, sell or otherwise dispose of the stock. It is common for full ownership of the stock to vest after specific increments of time e. g. 25% ‘vests’ after each year of performing services for four years. Or, the stock vests when certain performance goals are met.

Book Treatment – Restricted stock is expensed as compensation for the fair value of the stock as it vests (or is earned through service). Tax Treatment – As long as the restricted stock is nontransferable and subject to a ‘substantial risk of forfeiture’, an employee won’t recognize income until the risk lapses. If the vesting of the stock is conditioned on the performance of future services, a substantial risk exists. Thus, in the case of stock vesting incrementally over time and the performance of services, the employee will recognize income at each such increment when the stock becomes fully owned. The amount of income (which is subject to withholding in a method specified in the stock agreement) equals the fair market value of the stock at the time it vests times the number of shares vested during that particular increment of time. The bank will be allowed a corresponding compensation deduction at the same time the income is recognized by the employee. 83(b) Election – One option available to employees receiving restricted stock is to make what is called an 83(b) election which allows the employee to recognize for tax purposes the value of the entire amount of the restricted stock grant at date of award, rather than incrementally over time. This could be advantageous if the fair value of the stock is low at the date of award, the employee is unlikely to forfeit any shares, and the value is expected to increase substantially. If this is the case, then when the shares are sold, they may be subject to tax at long-term capital gain rates. However, if the employee pays the 83(b) tax, then subsequently forfeits the shares for whatever reason, no refund may be obtained. This election must be made within 30 days from the date of the award. Obviously, this is an election that should be made with careful consideration.

As with NQSOs, the timing of the compensation deduction for tax vs. book purposes can result in timing differences that will enter into the deferred tax calculation.

Phantom Stock.

Phantom stock is more like a deferred compensation plan than a stock ownership vehicle. Phantom stock doesn’t award actual stock but instead uses the calculation of dividends or appreciation on actual stock to determine amounts of deferred compensation that are credited to an employee’s ‘account’ for future payment at retirement. The employee is usually awarded a number of ‘units’ (determined by the administrative committee) where each ‘unit’ earns the same amount of deferred compensation as one share of stock earns in dividends, or appreciates in value. For example, if one share of stock would receive $100 in dividends, the employee has been awarded 10 ‘units’ of phantom stock, then $1,000 will be credited to the employee’s deferred compensation account for future payment. In addition, the account may be credited with increases in the market value of the stock. This has the advantage of tying compensation to stock performance while not actually diluting the interest of the actual stockholders. Phantom stock may also work well for younger executives who don’t possess the resources to exercise stock options.

Book Treatment – Compensation expense is booked for the amount of deferred compensation credited to the employee’s account (a liability account). When the payments are made in the future, the liability is debited. Tax Treatment – The employee will be taxed when the deferred compensation is actually received at retirement (when the employee is likely in a lower tax bracket). The bank receives a corresponding compensation deduction when the employee recognizes the income. This results in a timing difference between the book and tax treatment.