Invention

Stock Option (employee compensation)

Section 421 of the 1950 tax code turned equity into a compensation tool.

United States · 1950s
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Stock options as financial instruments existed long before they became a form of pay. Options to buy or sell commodities at a future price were traded in Amsterdam in the seventeenth century and in London and New York by the nineteenth. The idea of granting employees the right to purchase company shares at a fixed price arrived much later, as a deliberate piece of tax engineering.1

The Revenue Act of 1950 introduced Section 421 to the U.S. tax code, creating a framework for "restricted stock options" that allowed companies to grant employees the right to buy shares at a set price, with favorable tax treatment on the gains.2 The provision was designed to help smaller companies attract talent without competing on cash salary alone.

Silicon Valley embraced the mechanism in the 1970s and 1980s. Fairchild Semiconductor and its spinoffs, including Intel, used stock options to recruit engineers who might otherwise have stayed at larger, better-paying firms on the East Coast.3

The practice reached its peak during the dot-com boom of the late 1990s, when companies like Microsoft, Cisco, and hundreds of smaller firms created thousands of paper millionaires through option grants. At Microsoft alone, an estimated 10,000 employees became millionaires through stock options before 2000.4

The Financial Accounting Standards Board issued FAS 123R in 2004, requiring companies to record stock option grants as expenses on their income statements. Before that rule, options did not appear as a cost, which meant companies could distribute significant compensation without it reducing reported profits.5 After 2004, many technology companies shifted to restricted stock units, which vest over time but do not carry the same speculative upside as options.

1950
Revenue Act introduces tax-advantaged stock options for employees.
1970s
Silicon Valley companies use options to recruit engineers from larger firms.
Late 1990s
Dot-com boom creates thousands of paper millionaires through option grants.
2004
FAS 123R requires companies to expense stock options on income statements.
1 Lodewijk Petram, The World's First Stock Exchange (New York: Columbia University Press, 2014).
2 Revenue Act of 1950, Section 218, codified as Internal Revenue Code Section 421.
3 AnnaLee Saxenian, Regional Advantage: Culture and Competition in Silicon Valley and Route 128 (Cambridge: Harvard University Press, 1994).
4 Robert X. Cringely, Accidental Empires (New York: HarperBusiness, 1996), updated estimates in industry reporting.
5 Financial Accounting Standards Board, Statement No. 123 (revised 2004), "Share-Based Payment."
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