By now, stock options have become well known as a device for employee compensation in corporations. A stock option provides the holder with the right to purchase a share of the corporation at a stated price. When this “strike price” is below the price of the shares trading in the stock market, the options are considered “in the money” and the optionholder has an economic incentive to exercise the stock option. When the strike price is above the market price for the stock, the optionholder does not have an incentive to exercise the options.
Because stock options increase in value with an increase in the stock price, options are thought to be reasonably efficient incentive mechanisms, delivering value to employees when the firm succeeds. Because stock options issued to employees also vest over time, the existence of unvested options as part of an employee's compensation package creates a bonding mechanism between the corporation and the employee.