According to this study, exercise of employee stock options does result in dilution.
http://knowledge.wharton.upenn.edu/paper.cfm?paperID=1245
Specifically it increases the "float" of common stock. When an employee decides to exercise an (in the money) option, he/she pays the company an amount of money corresponding to the strike price of the option and the company issues shares (these shares are issued out of the company treasury and depending on accounting rules may not be included in the reported number of shares outstanding). The employee may then sell the shares in the open market (theoretically the employee could just hold on to the newly issued shares without selling them rightaway but there is no good reason for the employee to do this (he could have just held on to the options instead and saved the cash)
-raghu.
"It's not really dilution of the stock, however, since there's no new
stock being issued."
If no new stock is issued, I imagine then, that there is no guarantee
that when the time comes and the holder decides to sell his/her options
that there will necessarily be enough willing buyers? Or is the company
that issues stock options responsible for ensuring that all those
options (when exercised) will be purchased at the market price? In other
words, is the option holder guaranteed a future sale, or are they at the
markets whim?
