The premise of stock options is to tie the long-term financial performance of a corporation to its employees. This provides an "upside" where employees can make substantial profits if they all work in harmony and cause the business to perform well and increase the share price. Stock options are often "granted" to employees with no cost to the employee and a 'strike' price. This strike price is the floor where the employee can begin making profits. If you were issued options in ABC stock and the stock price was currently $15.00/share, a likely options strike price may be $25.00/share. When the stock appreciates to more than $25.00/share you gain any equity above that price. If the price of the stock remains below $25.00/share the options are worthless.
Stock options likely have been a large contributor to the recent string of scandals and corporate greed including Enron, Worldcom, Tyco & HealthSouth. Employees and executives tried so hard to drive stock prices ever higher, at any expense, that they lied and committed crimes. This ultimately became known as "cooking of the books." The motivation to drive stock prices higher was to increase the value of the stock options.
Many people who have received stock options in the past few years find themselves with worthless pieces of paper. This is because the current price of the stock is well below the strike price on the options granted. This is part of the stock option deal-when things go well you have the opportunity to make a lot of money and if things don't go well you gain nothing. You lost nothing because the options didn't cost you anything to acquire. When a stock option has a current price that is lower than its strike price it is worthless and often called "underwater." Just recently Microsoft began a program where employees can sell their underwater options to a bank and get a return on their investment. This is fundamentally flawed because it now allows the employees to gain financially even if the company doesn't do well.
Stock options became the "rage" in the 1990's when things were going extremely well for growth investing. Companies preached that this would be the best way to put management and employees interested in line with that of the owners of the company, the shareholders. Now in 2003 after the largest bear market since the 1920's there is a new plan. This new plan is to give employees regular shares of stock that do not expire. It will also allow the owners to participate in company dividends, which they were not able to do with stock options. I believe this will be better for everyone in the long term but the newfound bailout provision for currently worthless stock options should be illegal.