Final answer:
A stock option plan grants senior managers the right to purchase company shares at a predetermined price, serving as a motivation tool under corporate governance. Shareholders of a public company, who could be individuals or large investor groups, elect a board of directors to manage the company. Stock options are a part of the compensation framework aimed at aligning executives' interests with those of shareholders.
Step-by-step explanation:
A stock option plan is established to give senior managers of a company the option to buy the company shares in the future at a predetermined, fixed price. This is a strategy used by firms to align the interests of their senior executives with those of the company and its shareholders. Stock options are often part of a broader compensation package offered to executives and employees.
When financial investors buy and sell shares of a firm, we refer to it as a public company. Shareholders own a public company, and they elect a board of directors to oversee the management of the company. These directors, in turn, hire top executives to run the day-to-day operations. The overarching power structure is an important aspect of what is known as corporate governance.
The concept of stock options plays a critical role in how corporate governance functions in a capitalist system. It provides an incentive for senior managers to prioritize shareholder value since the profit from exercising stock options can be substantial if the company's stock price increases over time. For executives with stock options, it's not just a salary they are working for but a potentially lucrative share in the company's growth.
Generally speaking, stock represents ownership in the firm, and the owners, or shareholders, can range from individuals to large institutional investors. Even in cases where no single investor owns a majority of the stock, as is typical with large corporations like IBM or Microsoft, each share represents a fraction of the ownership, which in turn grants the investor a number of votes corresponding to their shareholdings.
Private companies, on the other hand, are not owned by shareholders in the same way. These firms may be owned by individual proprietors, partnerships, or private investors, and they do not sell shares to the public. Although different in structure, both private and public companies can use stock options to motivate and retain their executives and key employees.
In conclusion, the use of stock options as an incentive mechanism for senior management is a key feature of modern corporate governance. It reinforces the alignment between the executive's performance and shareholders' interests, ultimately influencing the strategic direction and financial success of the company.