What are employee stock options?

The most important facts in brief:

• Employee stock options are a Form of employee participation.
• Employee stock options give employees the opportunity to purchase shares at a later date at a fixed price. to acquire shares in the employer.
• Employees benefit from employee stock options Increases in value of the employer.

What are employee stock options?

Employee stock options are a form of employee participation in which employees have the opportunity to acquire shares in their employer at a later date. With an option, the employee is given the opportunity to acquire shares in their employer at a later date at a price that has already been set. If the value of the shares rises above the exercise price, the employee makes a profit. Employee stock options therefore represent a way of Employees benefit from the employer's value growth. Employee stock options are particularly common in listed companies, as only in these companies can the shares in the company be traded on the stock exchange.

The following terms are particularly important for employee stock options:

• Vesting periodThe Vesting-period is the period in which the employee receives or can acquire the options.
• Exercise priceThe exercise price is the amount at which the employees can later acquire the shares.
• Exercise periodIn the case of employee stock options, it must also be stipulated how long the options can be exercised and when they expire.

Example: An employee stock option plan provides for employees to have the opportunity to buy shares in their employer for € 20 in 2029. In 2025, 2026 and 2027, employees will each receive 100 such options. If the share price rises to € 50 by 2029, for example, employees who have received all options can buy 300 shares for € 20 each, which would be worth € 300 x € 50 = € 15,000 at the time of exercise. The purchase price would be € 6,000, meaning that the employees would make a profit of € 9,000 each.

How are employee stock option programs implemented in practice?

There are Various optionsto set up an employee stock option program. Such programs are often aimed at a large number of employees at listed companies. In some cases, however, only selected managers receive such options. The following options are available for setting up an employee stock option program: 

• Individual commitmentsWith individual commitments, often only individual employees receive options. Individual commitments are primarily used for managers. The great advantage of individual commitments is that individual arrangements can be agreed.
• Total commitmentEmployee stock options can also be issued to all employees in a single grant. The program can also be restricted to a group of employees. However, the principle of equality must be taken into account when restricting the program, i.e. comparable employees must be treated equally. Conversely, this means that there must be an objective justification as to why some employees participate in the program and other employees do not.
• Company agreementFinally, it is possible to introduce an employee stock option program by collective agreement, in particular a works agreement with the works council.

What must be regulated for employee stock options?

The employee options should be structured in such a way that there is no risk of legal disputes later on. The following aspects must therefore be regulated:

• Output conditionsWhen and under what conditions employees may receive options or acquire options.
• Exercise conditionsThe terms and conditions of the option must specify when and under what conditions the options may be exercised. In particular, the conditions of the option must stipulate how many shares may be acquired and at what price.
• DecayA particular focus in the case of employee options is on the regulations governing the expiry of the options. In particular, it must be regulated what happens to the options if the employment relationship is terminated. A distinction is often made according to the reason for termination, so that the options only lapse if the employee is dismissed for breach of duty or resigns.

Corresponding agreements - in particular the clauses on forfeiture - are subject to high effectiveness requirements. Depending on the structure of the employee stock option program, it is possible that these are general terms and conditions, meaning that the clauses must not unreasonably disadvantage employees (see BAG, 19.03.2025 - 10 AZR 67/24). However, if the exercise conditions are part of a company agreement, they are not subject to general terms and conditions control.

When designing the Employee Stock Option Program, you should consider the following aspects:

• Avoidance of windfall profitsThe aim of employee options should be to motivate employees to increase the value of the company. However, employees should not benefit from the fact that the overall market situation is improving (e.g. a generally better economic situation). It is therefore possible to set the share price performance in relation to industry indices.
• SourceWhen setting up an employee share ownership program, consideration must be given to the source of the shares. Either treasury shares can be acquired or a capital increase can be carried out. When acquiring treasury shares, Section 71 AktG must be taken into account, according to which the acquisition of treasury shares is only permitted to a very limited extent.
• ConsentDepending on the implementation of the employee stock option program, the approval of the Annual General Meeting may be required. If a capital increase is required to implement the program, the Annual General Meeting must give its approval, Section 193 AktG.
• Works CouncilIf the program is also aimed at non-executive employees, the works council may have a right of co-determination. However, this depends on the respective design of the program.
• Capital market lawAny restrictions under capital market law must also be observed, e.g. the obligation to report proprietary transactions by managing directors and the ban on insider trading.

Virtual options are much easier to implement. With these, employees do not receive real shares, but a bonus payment if certain conditions are met.

Advantages and disadvantages of employee stock options

Employee stock options aim in particular to reward employees for increasing the value of the company. They are therefore a way of solving the so-called "principal-agent problem". The principal-agent problem describes the situation where the management and the owners do not pursue the same goals. Depending on how they are structured, employee stock options also offer the following advantages:

• Employee retentionEmployee options are usually acquired successively. They therefore reward employees who remain with the company for a long time.
• Avoidance of dilutionThere is the possibility of structuring the options in such a way that the employees do not buy real shares, but receive the increase in value as a cash payment, so that there is no risk of dilution of the owners' share. 
• No dry incomeEmployee options can be structured in such a way that employees only have to pay taxes when they generate income themselves.

How are employee stock options taxed?

With regard to the tax effects of employee stock options, a distinction must be made between the tax effects at company level and at employee level. Employee stock options have the following tax implications for employees:

• Type of incomeSince the options accrue to the employee as a result of the employment relationship, this is income from non-self-employed work.
• Time of inflowThe time of the inflow determines the time at which the taxes must be paid. The inflow occurs when the option is exercised and the shares are booked into the securities account. For this reason, the shares are usually sold immediately after the option is exercised so that the employees have money to settle the tax liability. In the case of small and medium-sized companies, however, there is the possibility of a tax deferral for employees, § 19a EStG.
• HeightThe basis of assessment is the difference between the share price at the time of purchase and the exercise price. The entire "profit" must therefore be taxed as wages. There is an allowance of € 2,000 per year, § 3 no. 39 EStG in conjunction with § 19 para. 1 no. 1 EStG.

The costs of managing and setting up the program can be deducted in full at company level.

Alternatives for employee participation

Employee stock options are not the only way to give employees a stake in the company. The following alternatives to employee stock options exist:

• Restricted Stock Units (RSU)With restricted stock units, employees are automatically allocated shares. The difference to options is that with options there is only the right to acquire shares.
• Bonus paymentsThere is also the option of allowing employees to share in the company's success through bonus payments.
• Employee sharesEmployee shares are a popular form of employee participation for listed employers. Employees can buy shares in the employer at discounted prices. Employees are usually subject to minimum holding periods so that they can only sell the shares after a few years. When managers hold a stake in a company, this is sometimes referred to as "Sweet Equity" is labeled.