The Non-Option: Understanding the Dearth of Discounted Employee Stock Options

59 Pages Posted: 28 Jun 2008 Last revised: 29 Jun 2009

Date Written: October 17, 2008


Contemporaneous grants of both stock and at-the-money options to individual employees of U.S. public companies indicates demand for equity compensation packages that are in the money, i.e., packages of equity pay instruments that in aggregate have payoff profiles and incentive properties that are similar to explicit in-the-money employee stock options. However, several tax rules (and formerly accounting rules) strongly discourage grants of explicit in-the-money options, including recently enacted IRC - 409A, which essentially precludes the use of explicitly discounted options by taxing these instruments at vesting, rather than at exercise, and adding a 20% penalty tax. This article explores whether the tax and accounting distinction between discounted and non-discounted options makes sense.

The stated legislative rationales for rules discriminating against explicit in-the-money options are weak, reflecting a dichotomous view of equity compensation divided between discounted and non-discounted options, when, in fact, option design is a continuum. However, this article sets forth a novel tax policy rationale for forcing firms to bifurcate in-the-money pay packages into discrete grants of stock and non-discounted options, a combination that I refer to as a synthetic in-the-money option. In short, doing so precludes the unwarranted expansion of preferential option tax treatment to instruments resembling restricted stock.

Keywords: Employee stock options, In-the-money, options, Discounted options, NQSO, ISO, Restricted stock

JEL Classification: H24, H25, J33, K22, K34

Suggested Citation

Walker, David I., The Non-Option: Understanding the Dearth of Discounted Employee Stock Options (October 17, 2008). CLEA 2008 Meetings Paper; Boston Univ. School of Law Working Paper No. 08-30; Boston University Law Review, 2009. Available at SSRN: or

David I. Walker (Contact Author)

Boston University School of Law ( email )

765 Commonwealth Avenue
Boston, MA 02215
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Abstract Views
PlumX Metrics