"Many companies use employee stock options plans to retain and attract employees,[3] the objective being to give employees an incentive to behave in ways that will boost the company's stock price. If the company's stock market price rises above the call price, the employee could exercise the option, pay the exercise price and would be issued with ordinary shares in the company. The employee would experience a direct financial benefit of the difference between the market and the exercise prices. If the market price falls below the stock exercise price at the time near expiration, the employee is not obligated to exercise the option, in which case the option will lapse. Restrictions on the option, such as vesting and non-transferring, attempt to align the holder's interest with those of the business shareholders.
Another substantial reason that companies issue employee stock options as compensation is to preserve and generate cash flow. The cash flow comes when the company issues new shares and receives the exercise price and receives a tax deduction equal to the "intrinsic value" of the ESOs when exercised.
Employee stock options are mostly offered to management as part of their executive compensation package. They may also be offered to non-executive level staff, especially by businesses that are not yet profitable, insofar as they may have few other means of compensation. Alternatively, employee-type stock options can be offered to non-employees: suppliers, consultants, lawyers and promoters for services rendered. Employee stock options are similar to exchange traded call options issued by a company with respect to its own stock.
At any time before exercise, employee stock options can be said to have two components: "time value" and "intrinsic value". Any remaining "time value" component is forfeited back to the company when early exercises are made. Most top executives hold their ESOs until near expiration, thereby minimizing the penalties of early exercise. "