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- Beware: Stock Options Will Expire If Not Exercised
- Executive Stock Options | NBER
- Negotiating Stock Option Packages
That doesn't help him because he has no other capital gains. He is bankrupt! So much for motivating him with incentive stock options! Under the tax rules, the important point to remember is that a tax liability is assessed at the time when an option is exercised, not when the stock is actually sold. In the USA, the benefit is taxed as a capital gain if the shares are held for one year prior to sale!
Let's go back to the example of Jill buying Multiactive stock. Up until recently, she would actually have to pay the tax in cash. Nice, eh? Worried that she might have no profit, she sells. Not good. But true! She still gets no relief on her original tax bill. I wonder what happens if she never sells her shares? Would her tax liability be deferred forever? Again, this is OK. Because of the potential negative impact brought about by acquiring and holding shares, most employees are effectively forced into selling the shares immediately - i.
But, can you imagine the impact on a venture company's share price when five or six optionees "dump" hundreds of thousands of shares into the market?
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This does nothing to encourage employees to hold company shares. And it can mess up the market for a thinly traded security. From an investor's perspective, there's a huge downside to options, namely dilution. This is significant.
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From the company's perspective, the routine granting and subsequent exercising of options can quickly compound the outstanding share balance. This gives rise to " market capitalization creep " - a steady rise in value of the company attributable to an increased stock float. Theoretically, share prices should fall slightly as new shares are issued. However, these new shares conveniently get absorbed, especially in hot markets.
As an investor, is it easy to find out what a company's outstanding options are? No, it's not easy and the information isn't updated regularly. The quickest way is to check a company's most recent annual information circular available on www. You should also be able to find out how many options have been granted to insiders from the insider filing reports. However, it's tedious and not always reliable. The belief that options are better than company bonuses because the cash comes from the market, rather than from corporate cash flows, is nonsense.
The long term dilutive effect is far greater, not to mention the negative impact on earnings per share. Annual vesting will ensure that employees who get options do indeed add value. The term optionaire has been used to describe lucky option holders with highly appreciated options.
When these optionaires become real millionaires, corporate managers must ask themselves if their payouts are really justified. Why should a secretary earn a half million dollar bonus just because she had 10, "token" options?
Beware: Stock Options Will Expire If Not Exercised
What did she risk? And what about those instantly rich millionaire managers who decide to make a lifestyle change and quit their jobs? Is this fair to investors? Stock option rules, regulations and the taxation issues that arise are very complex. There are also substantial differences in tax treatment between private companies and public companies. Furthermore, the rules are always changing.
A regular check with your tax advisor is highly recommended. So, what's the bottom line?
Executive Stock Options | NBER
Whereas options are great, like most good things in life, I think they have to be given in moderation. As much as stock options can be a great carrot in attracting talent, they can also backfire as we've seen in the above example. Compensation: Incentive Plans: Stock Options The "right" to purchase stock at a given price at some time in the future. Stock Options come in two types: Incentive stock options ISOs in which the employee is able to defer taxation until the shares bought with the option are sold.
The company does not receive a tax deduction for this type of option. Nonqualified stock options NSOs in which the employee must pay infome tax on the 'spread' between the value of the stock and the amount paid for the option. The company may receive a tax deduction on the 'spread'.
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How do Stock options work? An option is created that specifies that the owner of the option may 'exercise' the 'right' to purchase a company's stock at a certain price the 'grant' price by a certain expiration date in the future. Usually the price of the option the 'grant' price is set to the market price of the stock at the time the option was sold.
If the underlying stock increases in value, the option becomes more valuable.
If the underlying stock decreases below the 'grant' price or stays the same in value as the 'grant' price, then the option becomes worthless. They provide employees the right, but not the obligation, to purchase shares of their employer's stock at a certain price for a certain period of time. Options are usually granted at the current market price of the stock and last for up to 10 years. To encourage employees to stick around and help the company grow, options typically carry a four to five year vesting period, but each company sets its own parameters. Advantages Disadvantages Allows a company to share ownership with the employees.
Used to align the interests of the employees with those of the company.
Negotiating Stock Option Packages
In a down market, because they quickly become valueless Dilution of ownership Overstatement of operating income Nonqualified Stock Options Grants the option to buy stock at a fixed price for a fixed exercise period; gains from grant to exercise taxed at income-tax rates Advantages Disadvantages Aligns executive and shareholder interests. Company receives tax deduction. No charge to earnings. Dilutes EPS Executive investment is required May incent short-term stock-price manipulation Restricted Stock Outright grant of shares to executives with restrictions to sale, transfer, or pledging; shares forfeited if executive terminates employment; value of shares as restrictions lapse taxed as ordinary income Advantages Disadvantages Aligns executive and shareholder interests.
No executive investment required.