I've noticed executives buy a lot of stock below market value, and then they sell it for a large gain. How can they do this?

By Jared Coulson AAA
A:

On October 30, 2006, a Google executive officer purchased 2,541 shares of Google at $9 per share and sold these same shares the same day at $475 per share. The end result of this executive's trading activity was a net change of zero shares, but a net profit of about $1,185,000. How can executives buy the shares so cheap and then sell them at market value making a large profit? The method behind this is employee stock options.

Basically, the company awards an employee an option that allows them to buy a certain amount of shares for a set price at a set amount of time. The employee purchases the shares from the company, which they can either keep as an investment or immediately sell, usually for a gain.

Stock options aim to motivate managers by linking compensation with company performance, which is measured by share price. Unlike market-traded stock options that are sold for a premium, employee stock options are given either as a portion of salary or a bonus. These options allow employees to share in the success of their companies. For managers involved with new companies, stock options are an attractive means of compensation, as the exercise price is often very low. When the company starts to perform well, such as the Google example, the executives can exercise their options for large gains.

For more information regarding options as a form of employee compensation, see The True Cost of Stock Options and Lifting the Lid on CEO Compensation.

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