Stock Market and Stock Option Plan
Should the company implement the proposed employee stock option plan? In a typical stock option plan, the employee is offered a specific number of shares which he/she can exercise (buy) at some specified time in the future. The price at which the employee can buy the stock is equal to the market price at the time the stock option was granted (grant price). The employee’s gain is equal to the market value of the stock at the time it is exercised, less the grant price.
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If the market price of the stock remains the same or decreases relative to the grant price, then the stock option is worthless.
Stock options are typically offered to managers, most technical individual contributors and about half of the other professionals. Smaller organizations offer stock options more widely, in some cases to all employees In THTF case, stock options are offered to the former category. There are various factors that Tsinghua Tongfang should consider before implementing the proposed employee stock option plan. Future growth Stock options are appropriate for small companies where future growth is expected. Being a young company, THTF looks to be well posed for future growth.
Cultural differences In China, there is high importance attached to feeling valued and having a sense of belonging. This results in Chinese companies having to maintain a good reputation for treating their employees well or risk unwanted attention. In the current economic climate, competitions for key employees are extremely fierce. Options, to a certain extent, do inspire loyalty and commitment and provide employees with a sense of ownership which is a unique and potentially powerful compensation tool.
However, research (Economist’s article “False Options”) has shown that unlike the US counterparts, the Chinese rarely exercise vested stock options during their tenures at the firm. This may be due to the perceived notion in China where cashing out stock option may suggest disloyalty to the firm since once the options are cashed, the alignment of ownership and management no longer exists. Thus, options become an ineffective measure. Hence, there may a need for the company to consider the level of understanding among its Chinese employees with regard to options. An option may become an ineffective measure as seen from above.
Educating employees is one resolution but the cost and logistical burden of such undertaking may outweigh the potential benefits for company and its employee. In THTF’s case, as the key management are pushing for the implementation of the stock option, it can be inferred that they do understand the usefulness of stock options. Retention Retention of employees is of great interest especially in the high-tech industry THTF was based in. Key management were highly sought after. Stock options can serve as a retention mechanism as stocks options will motivate employees to remain with the firm as they can see their investment grow.
Stocks options will also encourage less risk-averse and optimistic employees or have employees that can increase value to work at the firm. This may be aligned with THTF interests. Therefore, stock options can help to retained and attract suitable people to work at the firm. However stock options can fall underwater due to bearish stock market conditions rather than poor firm performance and cause major morale and retention problems. This may lead to stock options not having their intended effects. Still, in this THTF’s case, they are currently in a robust and high-growth economy, thus stock prices are unlikely to fall.
From an incentive point of view, employees benefit when stock price goes up, so stock options motivate employees to increase their company’s price. This si aligned with the shareholders interest as when stock price goes up, presumably value has been created. The stock options may get the employees to think like shareholders. Nonetheless, this may not be the case. An option holder does not share the downside in holding the stock. If the stock loses value, the option holder will simply just fail to exercise the option and thus avoid the loss. Risk that would scare off a shareholder is a matter of indifference to an option holder.
This may lead management taking too much risk as the upside to taking the risk gives high paybacks whereas there is virtually no downside. In THTF, other measures need to be put into place to make sure of the interests’ alignment before implement stock options compensation. Employees From the employee’s point of view, receiving stock options is a huge benefit as the employee can reap financial success from the firm. But is it really so? The executives may suffer from the more volatility then the market as they are too under diversified with their stake too over concentrated in a irm. Employees should not put their eggs – instruments and salary – into one basket. Thus, this will lead to the undervaluing of options by the employees. This shows that options are wasted on employees. Market Paranoia Stock options compensation may also lead to the market being deeply suspicious of the corporation. When top executives are paid in stock options compensation, they get huge compensation packages which are hidden away from public scrutiny. Furthermore, stock options also dilute shareholders.
Management may also manipulate the market before the stock options grant date to get a better deal for themselves which would lead to excess volatility. Thus, having stock options compensation may lead to distrust from the market, having long term adverse effects on the stock prices. Conclusion Given the current restrictions and ambiguities of the Chinese laws and regulations applicable to options, THTF should take a conservative approach to such practice. If THTF determined that the use of options is immediately necessary for the recruitment and retention of employees, the options should be granted.