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