Just playing devil's advocate a bit, but what would be the downside of just drawing a bright line that owning stock in your employer is inherently a conflict of interest?
If you believe that mechanism is sound, then I guess the downside would be that you have fewer incentives to maximize shareholder value.
If you take outside capital to accelerate your business on the assumption that the investors will make money as it grows, you're choosing to join that system, no one forces you to participate.
Although I suppose you could end up in a zero sum competition with another business for market share, and there might be an unstable nash equilibrium where you both might want to not raise money, but if the other raises significant capital they could crush you, so you are kind of systematically pushed to play the game to keep your vision alive.
I don't really believe that mechanism is sound. I mean, it likely has some sort of affect in that direction, but I don't really think that it's a strong one.
If an employee couldn't get stock options in a startup, then there would be significantly fewer cases where they would choose to join a startup over a more stable, mature company. Sharing in the upside potential is critical. Sure, that isn't a public company but it still demonstrates the mechanism is sound.
That's possible, of course. I haven't seen any data to support it.
In my own experience (which is not statistically meaningful), this is a weak effect. I strongly prefer working for startups and very small companies, and most of the engineers I've worked with have stated that things like stock options aren't important to them (that's part of why options are so widely referred to as "wallpaper").
The attraction to working for startups, for both myself and most of the people I've worked with, is that startups offer better working conditions and more interesting projects.
However, I do feel the need to underline that this is just my subjective experience and it may not representative overall.
Every company in YC Winter 2019 issues half its ownership to a pool. Every company receives, in return, shares of the YCW19 fund. Employee stock options are 100% issued from the YCW19 fund.
Is this better or worse for non-founding employees? More or less attractive than receiving stock options that only apply to the member company that they actually work for?
For example, once you are fully vested at a startup, the reason to stay is primarily if you think you have a material impact on the share price. If you don't, then you should leave to go somewhere where you do have a material impact and treat your shares in the original startup simply as an investment. In contrast, if you have a material impact, you should stay to maximize the value of your shares. Pooling everyone's shares, while better for the individual employee from a diversification perspective, reduces the ability of the employee to have a material impact on their investment.
Assume your prospective employees are economically rational. They have a couple of offers on the table, identical as to salary, benefits, and track record of existing founders. The only difference is that one is offering a tiny percentage of a lottery ticket that will pay out if they exit successfully, and the other is offering a tinier percentage of a lottery ticket that will pay out if any of their sister companies exits successfully. And there's little chance that you picked a unicorn, but a pretty good chance that somewhere in the cohort is a unicorn.
Being in that cohort becomes a hiring advantage if you get to share in their success.
And thus CDOs were invented...
Historically we've said the pros outweigh the cons but I'm really not sure we can accurately assess the risk of insider trading anymore because the definition of it is constantly changing.
Maybe you could limit the rule to publicly traded companies, but then people would have to decide whether to sell all of their stock or leave a company when it went public, which doesn't seem fair to the employees or good for the company.