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Jason Pang

Employee Stock Options

The biggest problem in modern organizations is a clash between ownership and management. To ensure the expansion of shareholder wealth, the pursuit of profitability maximization (particularly in the short term) must be cautiously balanced with the interests of the employees.

Significant employee benefit costs are likely to be required to maintain staff morale and lower attrition, which can have a negative effect on the business’s bottom lines.  While it is true that financial rewards are a direct source of employee motivation, the goal of interest alignment could not be achieved.

Such a situation gives rise to new incentive types, such as share-based payments. In this newsletter, we have examined the fundamental ideas of accounting and valuation for these share-based payments.

Employee stock option plan (ESOP) is a category of employee benefit plan that is among the most often used share-based payment by businesses. They are structured to encourage employees to purchase company stock or other forms of ownership.

On the surface, improving employee morale and retention would appear to be the main ESOP benefits for the company. Paying employees through ESOPs can be a more practical option than monetary awards for such businesses that are establishing or expanding their company strategies or operations.

There are more benefits of ESOP which include multiple tax advantages, a corporate finance technique to raise additional equity, and refinance outstanding debt/ acquiring assets.  It also provides an employee with significant retirement assets if they are employed by the company for a significant period, which enhances job security as well as their commitment to work.

Other fundamentals of ESOP that you can find in the newsletter are:

  • Accounting guidance of ESOP.
  • Recognition of compensation cost: How and when to measure the compensation cost?
  • Option pricing models: Black Scholes model (BSM) and Binomial model.
  • Disclosure requirements.

As a concept, ESOPs have developed to be a well-liked incentive, especially for start-up businesses, by providing a resolution to the tension between management and ownership. To match employee interests with those of shareholders, ESOPs are a component of the remuneration package for employees.

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