Are Stock Options the Answer for Japanese Firms in the U.S.?

When U.S. social networking company LinkedIn Corp. went public last May, many of its employees became instant multi-millionaires based on their stock options. In Silicon Valley, LinkedIn is not at all unusual for its heavy use of stock options as a form of compensation, and its experience demonstrates why options are so popular.

A Japanese software client of mine recently asked me whether he too should offer stock options to employees of his company's new U.S. entity. An executive recruiter had insisted my client couldn't hire top-caliber staff in Silicon Valley without an options program. While stock options can be a powerful tool for the right kind of employer, I'm afraid they're not well-suited to many Japanese companies in the U.S.

In essence, a stock option is a promise by a company to sell a share of its stock at a fixed price, subject to some restrictions. As with LinkedIn, an option becomes highly valuable when the price of the company's stock goes up – and it becomes worthless when the price of the stock falls below the price of the option.

For an employer (especially a privately held, early stage company), options offer several excellent benefits. First, they help a company hire great people while conserving cash. Employees are often willing to accept lower cash compensation when they receive options that might increase significantly in value over time.

Second, executives (and investors) believe that employees who own a piece of the business work harder and produce higher quality work because they see themselves benefiting directly from their own work.

Finally, companies see options as a great recruiting and retention tool. Any potential new hire will hear again and again that, just like staff at LinkedIn, she too might become very wealthy. Likewise, existing employees have a strong incentive to stay at a growing company in order to vest additional options and realize the value of their option holdings.

Sounds like a perfect tool for Japanese companies that often have trouble hiring top-caliber American employees, right? Well, not necessarily.

First, options are worthless unless there is ultimately a way to sell them – and at a higher price. Since few Japanese subsidiaries will go public in the U.S. or be sold off to another company for a high price (the most common "exit" paths), the likelihood of a big payout is significantly lower than in a venture-backed company maniacally focused on a high-growth path to exit.

Second, option plans require infrastructure. Employers spend thousands of dollars on attorneys and staff to create and administer an options plan – and international stock plans are even more complex.

Finally, to use options effectively, the company management must be skilled communicators. As the former leader of a company that used options heavily, I was always surprised by how much effort it took to get employees to think and act like "owners" of the business.

Used well, stock options can be powerful tools. However, I expect that most Japanese companies would benefit more by figuring out how to find good candidates on LinkedIn than by trying to convince potential hires that they will be the next LinkedIn.

Return to Resources