Individuals (and institutions) become shareholders for economic motives (dividends/capital growth). The ability of a company to meet shareholders’ objectives by paying a high dividend and/or having an increasing share price depends upon the future profitability of the company. If decision-making was in the hands of the shareholders then one would assume that all decisions would be made in the pursuit of profitability. However, the divorce of ownership and control has put the responsibility for decision-making in the hands of professional directors/managers. It follows that decisions made by directors/managers ought to be consistent with shareholder wealth objectives. However, the directors/managers have considerable scope for pursuing their own personal objectives which might not be identical with those of the shareholders i.e. there is likely to be a lack of complete goal congruence, and shareholders’ objectives might be subordinated to managerial objectives.

Share option schemes for managers (and other schemes discussed below) are intended to harmonise managerial and shareholder objectives by giving management the same wealth objectives as the shareholders. Managerial and shareholder objectives are still unlikely to become perfectly congruent since managers are likely to have objectives other than wealth maximisation to be satisfied through their employment (e.g. power, status/esteem, control over resources etc) which might not be perfectly correlated with wealth maximisation.

If managers are motivated by wealth objectives then they are likely to take decisions in line with maximising the share price at the exercise date and to maintain/increase the price thereafter, in which case shareholders’ interests will benefit.

Share option schemes for employees (as opposed to managers with decision making authority) are introduced for the same reason as those for managers, to improve profitability by working more efficiently/effectively.

For a ‘reward’ to be effective as a motivator it needs to be of a significant amount and the recipient needs to be able to associate the reward with the actions which gave rise to it (i.e. efficient working leading to higher profit). In the case of share option schemes for employees if the number of shares which the employees could take up is high, and the company is fairly labour intensive then the shareholders’ equity could well be diluted. If the number of shares per employee is small then the scheme is unlikely to act as a motivator.

If the options were to be given every year or twice per year, it would be difficult for the employees to associate such a ‘reward’ with their own effort. For any particular employee the amount of corporate profit will almost entirely be outside his/her control. Managerial decisions, conditions in resource and profit markets, competitive actions etc. all have a very significant effect upon the level of profit and are not controllable by employees throughout the year. It is doubtful whether a share option scheme based on annual profit could motivate an employee to work more efficiently during any particular day or week. his/her effort in any short time period would have no noticeable/measurable effects on the corporate profit for the year. Shorter term bonus schemes relating to the efforts of individuals or small groups and based on their measurable performance are more likely to act as motivators.

In summary, share option schemes for managers are likely to benefit shareholders while those for employees in general are less likely to have much benefit except to the extent that they may influence employees to take a greater interest in the affairs of the company.