Employee Stock Option Plan (ESOP)

Under an ESOP, employees receive options that allow them to buy a certain number of shares at a set price, called the exercise or strike price, usually equal to the share's value when the options are granted. Options typically vest over several years, encouraging employees to stay with the company.

If the company's value rises, employees can buy shares at the lower exercise price and benefit from the difference. For example, an employee is granted options to buy 1,000 shares at 5 each. Four years later, the shares are worth 20. Exercising the options costs 5,000 for shares worth 20,000, a gain of 15,000 before tax.

ESOPs are especially common in start-ups, which often cannot afford high salaries and use options to attract talent and give employees a stake in the company's success. Companies typically set aside a pool of shares, often 10% to 20%, for employee options.

Terminology and tax treatment vary considerably between countries. In the United States, ESOP more commonly refers to an employee stock ownership plan, a retirement plan that holds company shares for employees, which is a different arrangement. Several countries offer tax-advantaged share option schemes for employees.