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Options over shares as an incentive system for directors
Option contracts that are written on the epigraphs above are very different from some incentive systems that along these last years many companies have started. These systems consist in giving their employees options over shares (stock options). One of the most famous cases is that of the telephone stock options.
These incentives consist in giving the employee the right to acquire a determined number of shares at a prefixed price. If the shares rise the employee will be encouraged to exercise the option due that the exercise price is lower than the market price of the shares. In this case, the employees will exercise the option to acquire the shares to then sell them afterwards and this way get a profit.
The main advantage of the options over the shares is that the objectives are in accordance to that of the employees and of the shareholders, due that both groups are interested for the market price of the shares to rise. It is about an incentive that joins the employees and the company in long-term periods.
According to the consulter towers Perrin/Marco, 85% of North American companies offer their directors incentive plans that are based in options over shares, also according to the same consultant, the options over shares represent 40% of the total retribution of the North American directors.
However, there are companies that cannot start these kind of incentive plans based on options over shares because of some of the following reasons:
- it is a company that is not quoted in the stock exchange market
- they are not interested in issuing more shares
- the shareholders are not interested in giving up any of the shares that they possess
- many family companies for example, live this situation when the shareholders members of the same family to be a shareholder of their company. In these situations it might be interesting to begin with an incentive plan of phantom share options. The shares receive the denomination of phantom because the share for which you have an option are from the actual shareholders that will not be transmitted to the employees. These options consist in an incentive system that has the following characteristics:
- the incentives that are paid in cash are determined in relation with the increasing of value of the shares over which they have option to.
When an employee exercises the option, they do not get shares. What they do is pay them in cash the difference between the present value of the shares and the value they had when the option was given.
Putting to work an option plan over phantom shares, requires establishment extremes such as the following:
- directors and employees that may receive options
- a way to quantify the options that are received
- conditions in which the options are received
Usually, the companies have a maximum sum fixed for the value that is paid in cash to the employee that exercises the option.
Due that this system of incentives is usually used by companies that do not quote in the market, there is the problem of how to value the market price of their shares. For it, it is essential to periodically proceed to value their shares. This valuation is done with a pre-established system at the moment in which you start an incentive plan. If not done it will be impossible to settle an options scheme over phantom shares.
Among the main advantages of this incentive system, we must emphasize the following:
- it is not precise to issue or to sell shares to the employees or to the directors. So participation of the actual shareholders are not diluted.
The employees will be encouraged to try to rise the value of the company?s shares, and also they will act in a coherent way with the objectives of the shareholders. In other type of incentives you do not always obtain this kind of liveliness between the interests of the employers and that of the shareholders.