History

• In the 1990s, it was extremely common to forgo a high salary in high tech and instead focus on a good stock options package. The idea was that as your company did well, your salary would be only a small slice of the overall compensation you received as the value of your stock went through the roof. This worked well until the tech bubble burst in the late 1990s.
  
  

Function

• The idea behind compensating employees with stock was two-fold: It was an easy and cheap way to compensate employees, costing the company little to lock in a share price and offer 50 or 100 share of common stock, and it motivated employees who would see the direct result of their labor as the company continued to climb in value.
  
  

Effects

• The issue, of course, is how to account for this type of compensation with other shareholders. After the tech bubble exposed the tremendous potential value that employees held in companies due to their stock options, accounting rules changed. While salary has always been a part of financial reports, now a company also needs to identify what exposure it has in terms of employee stock options.
  
  

Time Frame

• Most stock options, unless otherwise noted, have a 5-year vesting. An employee is granted stock that will vest 20 percent each year at a specified price. If, for example, an employee is granted 100 options at $10, the employee has the right to buy 100 shares of stock for $10 at the end of 5 years--20 shares after 1 year, 40 shares after 2 years, and so on until the fifth year. If the stock increases in value, any amount above $10 is of benefit to the employee and contributes to the employee's overall wealth. While salary may change minimally during that time, stock options have the potential to skyrocket.
  
  

Warning

• Pay attention to a company's financial reports when stating exposure to stock options and salary. If the company is refashioning its compensation model to increase salary and constantly restriking the price of options, two things are going on. First, employees are not realizing any value in the stock, so there is no incentive to stay until their stock vests. Second, the company is not paying market value in terms of salary--not a problem during high-flying days of increasing stock value, but a significant issue when stock is being trampled. Turnover is an issue in this sort of environment. This can cause a downward spiraling effect on a stock as talented employees leave for significantly better salaries and forgo stock options.