![]() ![]() “An option’s value is enhanced by the ability to use the capital that would otherwise be invested in the stock for some other investment,” said webinar panelist Bill Dillhoefer, CEO of Net Worth Strategies (creator of the StockOpter decision-making tool for employee stock options).įor example, he explained that if your options have a 10-year term and the company’s stock price keeps rising, the options have growing tax-deferred value before you have spent any money on them. Financial advisors often liken stock options to an interest-free loan. Opportunity Cost And Exercise TimingĬonsider also the opportunity cost of exercising and holding NQSOs. In other words, the “Tao of Stock Options” might be the paradox that doing nothing for as long as possible could confer the greatest value. As long as the stock price continues to rise, thus increasing the spread over the exercise price, the leveraged value of the options grows without any tax hit, and your net after-tax proceeds will be larger. Before you exercise your options, their built-in value is subject to pre-tax growth that can be significant.įor all of these reasons, the panelists in the myStockOptions webinar agreed: often no advantage exists in exercising nonqualified stock options in a public company soon after vesting, paying taxes on the spread, and then holding the shares for long-term capital gains (unless special circumstances occur, such as job termination). Moreover, while cash bonuses and most other forms of compensation are taxable when you receive them, stock options defer taxes until exercise. Thus it’s important to think carefully about the right moment to make that move. “I mean, maybe Janet Yellen should get higher pay for that, but CEOs certainly shouldn’t.Option leverage: a percent increase in stock price gives a much greater increase in option value Īs soon as you exercise the options and thus purchase actual shares of stock, the leverage ends. “If you’re really talking about performance, you should not get higher pay when your stock price goes up because the interest rate goes down,” he explains. What’s more, says Stiglitz, the performance exception didn’t really reward “performance” as much as any number of other factors, such as monetary policy that boosted stock prices. Why does this matter so much now? Because it contributes to growing inequality and a lackluster economic recovery, by putting more and more tax-free compensation into the hands of the wealthy (who tend not to spend it after a certain point, which is a problem in an economy based mostly on consumer spending). I argued very strongly during the nineties that the whole stock option pay trend caused a lot of incentives for non-transparency, and that it was directly responsible for what I call creative accounting.” It allowed firms not just to deceive the market but also to avoid paying the taxes that they should have paid. I had written a lot about this before, that it was largely phony. As Stiglitz puts it, “It just opened up this huge span of bonus pay which was not for performance. This further fed the cycle of short-termism since executives would from then on be focused primarily on boosting stock prices, by any means necessary. That’s because it created a tremendous incentive for companies to pay more compensation in options. Joseph Stiglitz, a former head of Clinton’s Council of Economic Advisers, remembers this move as “one of the worst things that the Clinton administration did.” The measure limited corporate tax deductions for regular salaried income to $1 million but exempted “performance-related” pay above and beyond that-pay that was typically awarded in stock options. Key legislative changes that fueled the trend happened under Democratic president Bill Clinton, whose administration passed a 1993 provision on corporate pay. It marked a turning point toward short-term decision-making in corporate America. It’s worth understanding just why, and how, stock-based compensation became such a huge deal to begin with. After all, employee compensation, whether paid in cash or stock, is obviously an expense that should go on the balance sheet. (This piece is a great primer on how the funny math works.) But recently, Facebook started including stock comp in its reporting, and there’s a big push within corporate governance circles to get more companies to do that in order to get back to a more realistic version of earnings. LinkedIn isn’t alone in this sort of crafty accounting–most companies in the S&P now do it. ![]()
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