The stock markets' recent volatility has taken the shine off employee stock options internationally. Once the holy grail for job seekers, a new phrase "underwater options" has been coined in the United States to describe employee share options that are now worthless.

Paper millionaires have become pulped paupers overnight. Fearing a mass employee exodus, Microsoft recently announced that new stock options would be granted to all 34,000 full-time employees to compensate them for the stock's 40 per cent nosedive this year.

Employee share option plans (ESOPs) in the Republic do not typically offer the huge financial incentive of some US schemes.

A company with a share option plan provides its workers with the opportunity to buy shares in the company at a certain price, called an exercise or strike price. Most option contracts stipulate that the shares may not be bought before they vest - or the period limiting purchasing expires. When shares vest, employees are entitled to buy them at the strike price. This may be from three to seven years and the timing is meant to reduce employee turnover and increase loyalty.

The advantage for employees is that, usually, the strike price is lower than the market price. For example, a firm may offer employees the chance to buy their shares at £5 a share when the market price is £10. Employees then have an immediate profit of 50 per cent before taxes.

This trend has reversed for the moment and some employees find that the strike price is higher than the company's market value making the option worthless or "underwater".

Most Irish share schemes have not suffered the fate of US technology companies. For example, last Thursday one Bank of Ireland share cost €7.35 while the employees strike price is €5.4. If an employee's shares were vested, they could buy the share at the strike price and make a profit. Since Bank of Ireland's newly introduced Save as You Earn (SAYE) schemes only vest after three, five or seven years, employees are not missing out on an opportunity for gain.

Internationally, technology company employees are those most likely to feel the waters rising around their share options but this does not appear to be a problem here.

Iona Technologies' Mr Danny Mauerhofer says: "Share options are a huge incentive for employees because it's such a competitive market." Underwater options are not an issue at Iona, he said.

Companies that are not publicly listed may also make such schemes available. Last week for example, An Post introduced an ESOP for its employees in an effort to reduce overtime costs which were eating into the company's profit margin.

Six types of plans are available in the Republic: employee share-participation plans, share-option plans, share-purchase plans, save as you earn share option plans (SAYE), restricted share plans and share-subsciption plans.

SAYEs are more attractive from a tax viewpoint as Revenue collects duty from such investments at the capital gains tax rate of 20 per cent rather than the income tax rate.

Under SAYE schemes, which are popular in Britain, employees receive options to purchase shares in their employer's business at the price prevailing at the time the option is granted or in certain circumstances at a discount to that price.

To pay for the shares, employees agree to save between £10 and £250 per month for either three, five or seven years with an approved savings institution.

Six months after the end of the option period, the employee may exercise the option at the agreed option price or withdraw the money, with accrued interest, tax-free.

If the rules are followed, any profit from the disposal of the shares is subject to capital gains tax at 20 per cent rather than to income tax. The capital gains tax exemption of £1,000 per year may help reduce an individual's tax liability on the sale.

Even though employees are still clamouring for them, share option schemes have not really taken off as expected, says Beckett's employee benefit consultants' Mr John McGovern.

"I think it's very limited in its appeal. American companies are not that interested in it because they have to set aside shares in a trust for a number of years," he said.

This difficulty is compounded by shareholder demands as the company must convince them that such dilution of their shares is justified. Irish companies will probably come to the same conclusion as their US counterparts, says Mr McGovern.

Many US firms are now giving employees straightforward, taxable share options, he said.

With the exception of SAYEs, most shares that result from option schemes produce an income tax liability on the difference between the share price when the employee sells and the strike price. "This is working against us in Ireland because many companies can't attract the employees they need due to the tax situation," says Mr McGovern.

The current underwater options situation may teach a valuable lesson to workers. "I think it'll wake up some of the younger employees and show them that it's not all about share options. Employees may now look for core options and a more balanced benefits package," he said.