Stock options have been widely used in the United States as one component
of their compensation packages. Corporate managers and employees who are
awarded stock options can exercise the options to purchase a certain number of
their firm's shares at a predetermined price during a specified period of time.Theoretically, stock options are used to reduce agency costs by aligning the
interests of managers and shareholders. But in a practical sense as well, stock
options are a good vehicle to preserve the balance between short- and long-
term performance, since they focus on the firm's stock price. Stock options also
are especially useful for start-up firms that may have difficulty finding the
liquidity necessary to pay salaries and finance their investment opportunities.
Stock options can be used to complement the relatively low salary of start-up
firms and help them secure better labor forces. Considering this, the minister of
labor affairs announced that the Office was preparing a program to help small-
and medium-sized Korean firms use stock options.There are three important points in time related to stock options: grant date,
exercise date and transaction date. On the grant date, the firm awards stock
options to its employees. On the exercise date, employees exercise the option to
obtain the firm's stocks if the market price is above the exercise price. On the
transaction date, the employees sell the stocks obtained. At each point in time,
accounting and tax issues are involved.For accounting and taxation purposes, stock options can be classified as
incentive stock options (ISOs) and nonqualified stock options (NSOs). The ISO
is favored by the federal income tax law. On the other hand, the NSO is not
qualified for the preferential tax treatment. To be classified as an ISO plan, the
following requirements must be satisfied (Harvard Business Case #9-386-090, 1985):
| 1. | Stockholders must approve the plan within 12 months before or after its adoption. The plan should state the aggregate number of shares subject to the options and the employees who are entitled to receive them. |
| 2. | The options must be granted within ten years from the date the plan was adopted or approved by the stockholders, whichever is earlier. |
| 3. | The term of the option must not be longer than ten years. |
| 4. | The exercise price must not be less than the stock's fair market value at the time the option is granted. |
| 5. | The option, by its terms, must not be transferable except in the event of death. |
| 6. | The optionee, at the time the option is granted, may not own more than ten percent of the issuing company's combined voting power. This condition may be waived if the option price is equal to 110% of the stock's fair market value at the time the option is granted and the option term does not exceed five years. |
| 7. | The option must not be exercisable while there is a previously granted ISO outstanding. |
| 8. | The plan must limit the fair market value of stock for which an optionee may be granted options in any one year to $100,000 plus any unused limit carried over to such year. This unused limit carryover equals one-half of the excess of $100,000 over the fair market value of the stock for which the optionee was granted ISOs |
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