Explain premium-priced stock options. What are their advantages and disadvantages in terms of aligning employee interests with shareholder value?
What will be an ideal response?
Premium-priced options set the exercise price above the current share price by a certain percent (e.g., 25%, 50%, and 100%). Their main advantage is they reward employees only if share price growth exceeds a hurdle rate, rather than rewarding any and all increases in share price. Their main disadvantage is they do not reward or penalize employees for their relative performance. For example in a down market (when all shares in an industry are falling), they do not reward the employees of companies whose shares are falling less than average. Similarly, in an up-market, they do not penalize the employees of companies that are performing worse than average but better than the hurdle rate.
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