By opening stock options to middle management and employees, it was assumed that better employee performance would be incentivized. As company stock prices go up, it creates a greater spread between the option price when it was granted to the employee and the hypothetical sale price at the end of the vesting period. Consistently better performance over a longer period of time would yield greater reward when the option is exercised. However, as Hall and Murphy again point out, "even if employees can increase the value of the firm, their share of that gain through their option holdings is very small. Combining this enormous free-rider problem with the risk imposed on employees through stock-based pay, it seems obvious that cash-based incentive plans based on objective or subjective performance measures can provide stronger and more efficient pay-performance incentives."
Despite many early statements in the life of the practice that employee stock options serve as an incentive to yield better performance, empirical data seems to show otherwise. "The prevalence of vesting periods for options and the requirement that employees immediately exercise options when they leave the company suggests that firms use options to retain employees." (Core, 2001) but, employee stock options also enormously increase the risk to the employee; such risk was, in the Old Economy, reserved primarily for upper level management, as they are the primary forces behind a firm's value. Oyer and Schaffer conclude, in fact, that the incentive for increased...
Further, firms would in fact be much better off spending money on some other means of employee compensation that would not radically increase employee risk. (Oyer, 2005) They go on to argue that the actual motivations behind employee stock options are sorting (optimistic employees tend to accept employee stock options at a decreased cost of compensation to the company) and employee retention.
Swedish telecommunications company Ericsson seems to be a notable exception of a firm that has successfully altered the nature of its employee stock options from one of attempting to manage the labor market (attracting and retaining talent) to one of actual employee incentivization. Prior to 2000, employee stock option plans were a uniquely American means of allocating compensation. Because European markets tended to follow American New Economy trends, individual firms were able to make strategic selective adaptations. Glimstedt, Lazonick and Xie have extensively charted the steady transformation of employee stock options at Swedish telecommunications firm Ericsson, whose stock option plan shifted from:
"(a) the 1998 plan for a select group of high-level executives, comprising less than one-half of 1% of Ericsson's labor force, to (b) the 1999 plan aimed primarily at dealing as well with highly mobile high-level employees of New Economy firms that Ericsson had acquired in the U.S., and comprising
