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The main advantage of using this kind of an incentive plan is that it, at least hopefully, aligns the interests of the employee more closely with that of the company. When a company gives employees stock options, it is literally giving them ownership of the company. If they are part-owners of the company, they will have a very strong interest in having the company do well. They will be less likely to do the minimum possible and will be more likely to work harder so as to increase the value of the company (and, thereby, the value of their stock).
There are two main disadvantages. First, if the stock options are not crafted carefully, employees may simply take them and run. They might sell the stocks and/or leave the company as soon as they are able to do so. At that point, they no longer have the incentive they previously had. Second, stock options can encourage bad behavior on the part of upper management. They can encourage the management to try to manipulate the firm’s stock prices to their own benefit. In other words, the upper management might do things to try to create gains in the short term even if those actions will be harmful to the firm in the long run.
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