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How Employees Value Their Stock Options
Slyfox writes: "Do we over-value our stock options? How highly do you value your stock options? UPenn's Wharton School recently published
an article based on findings from a survey of employees about stock options. They find that many employees over-value their options and often don't fully understand how their stock options work. Are companies using stock options to trick their employees into working for less compensation?"
Anyone accepting stock options instead of proper compensation for a 40-hour work week needs to have their head examined, in this economic climate at least.
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"Remember when the U.S. had a drug problem, and then we declared a War On Drugs, and now you can't buy drugs anymore?"
There is no substitute for a good wage. Period.
Lump sum bonuses are subject to a horrendous tax rate and no, you don't get it back at the end of the year.
Stock options are a soggy deal for most rank and file employees for a variety of reasons.
1. Only the people in the inner circle get the lowest strike price and large number of shares.
2. There are usually a variety of restrictions placed on the exercise of these options which tend to minimize the profits the employee can make.
Usually, employees are compelled to use a broker stipulated by the company. This allows the company to control the rate at which the shares are sold. One phone call can halt a sell off. In general, the use of a single broker will delay transactions if for no other reason than you can't get anyone to answer the phone.
There are often self-imposed "blackout periods" in which employees are prohibited from selling their shares. These usually occur during the end of the quarter when the quarterly profits are being announced. The ostensible reason given for the blackout periods is to avoid the appearance of insider trading.
3. By now, everyone is familiar with what happens to stock options when companies go under or the stock market crashes but those are not the only things which can exert large downward forces on the price of the stock. A company I worked for was sued because it's officers had stolen source code from a competitor they had previously worked for. The stock value was depressed for 6 years because of this. There are other surprises which can erase paper fortunes.
By all accounts, I was lucky. I sold all the stock I had in my previous employer in '98 and got out while the gittin' was good. I bagged upper 4 figures after taxes, enough to put down on a good car. But I didn't get rich and considering the overtime I put in, this was chump change. Stock options are like a blow job; they look alot better than they actually feel. I definitely believe stock options are a gimmick to hold down salaries.
I'm sorry for honest, hard working people who have been screwed by the market downturn. I feel their pain. But at least this downturn has forced a hugh reality check about all the stock option business. I grew weary of listening to braggarts gloating about their paper fortunes. This downturn has shut them up.
Wansu, th' chinese sailor
If you wouldn't normally buy the stock from a regular broker or online trader, why would you want to be paid in the stock?
Keep that in the front of your mind: "If I were working at Wal-Mart, would I buy this stock?" If the answer is no, ask for money rather than stock. If yes, go for it.
If you wouldn't buy it normally, what makes you think it's worth anything, other than the say-so of somebody else (who you don't _really_ know) -- it's conceptually similar to fully trusting the salesman who hosts an infomercial on late-night TV when he says it slices and dices and will cut the fat by 80%.
When I worked at Worldcom, I would take options as payment -- Worldcom stock is worthwhile stock. If I had been working at Pets.com, I would not have taken options -- it's outside of my risk tolerance to buy startup-stock.
Potato chips are a by-yourself food.
Keep this in mind: it is always in your employer's best interest to pay you as little as possible without making you stop working. Any way management can motivate you to work without actually giving you any money is great for the bottom line. Managers also know that money not yet paid is a stronger motivator than money already paid (and spent). While it's counterproductive to think of your boss as your enemy, it's just plain stupid to meander along thinking his or her best interests are the same as yours. By their very nature, they are not.
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Proud member of the Weirdo-American community.
Useful link for more info on options: www.myoptionvalue.com. While there, check out The MOV School.
now we need to go OSS in diesel cars
That said, you should be aware that there are a lot of "catches" with ISO (incentive stock options).
1. You have to have cash on hand to exercise them. 500,000 options at $1 for a $100 stock do you no good if you don't have half a million on hand.
2. You have to pay short term capital gains, even if you don't sell. You must pay taxes on the difference between your strike price and the current market price. If the stock went up a lot ($99 in the previous example), you have to pay $36 in taxes per share immediately-- even though you haven't sold your stock yet! People have lost a lot of money on ISO's this way.
3. ISO's are not necessarily honored if a company is sold. If the company is not publicly traded and is forced to sell or liquidate, preferred shares are paid off first. ISO's get whatever is left, which may be nothing.
-m
I've seen so many people burned by stock options it's not even funny. One of my friends was on the verge of making bank on some stocks, they even had a ticker symbol, and everyone was just waiting for the stock to appear and cash in on the money. Before the company hit their IPO date, they laid off half the company. Needless to say they never went public. People who gave up a large chunk of salary to strike it rich off of stock options didn't even have a job after it was all over. Talk about a waste.
My experience was a better one, although that's not saying a whole lot. I actually did make money off of my old employers stock option program. This was during the period when everyone was making bank on tech stocks. Every week we saw stocks going IPO for $20/share and skyrocketing to over $100. My company gave me 8500 shares of stock at a price of 25 cents/share to be paid when I cashed in on the stock (called the "strike price"). Even if the stock only went to $20/share, I'd still be makin buko bucks.
Well it turned out that instead of going IPO we got baught out, which was fine with me, my stocks were vested, and now I could cash in. I awaited the deal that was to be made on how much our shares would be worth, etc. I still figured I'd make it big.
When the news came back, reality hit me big. We were being offered ONE DOLLAR PER SHARE. Now $8500 is a nice bonus, but after paying my strike price and taxes, I ended up w/ only $3500, a far cry from the six figures I was expecting, since that's about all the company talked about, practically getting people to work there just for stock and the opportunity to strike it rich. On top of that it was a horrid place to work. I put in 3 years for that stupid extra $3500 when I could have had a better job and been paid more to go somewhere else.
3 days after I cashed my option check I quit the company, and did find a better job, and got almost a $10k raise. I will never EVER take stock options again, even if I'm offered them. They don't call them "golden handcuffs" for nothing.
This is my honest opinion. You may disagree with me.
"Profit Sharing" and "Stock Plans" tie the company's profit to the worker's financial well being. If the company does good, you do good, so you work harder to get a pay off. This means companies dont feel the need to hire managers to make sure people are working which pushes the burden of organisation onto the worker. But at the end of the day you're still working to make someone else rich. Salary + options slavery vs wage slavery. It's still slavery.
How we know is more important than what we know.
The real success of stock options, as I recall, began with Micro$oft. I'm sure other companies were doing it, but Micro$oft was certainly in the forefront of the tech companies doing it.
.com boom, but not as many as advertised. Most of those were on paper and turned to nothing in the following "crash".
Everyone has heard the stories of millionaires made at Micro$oft, and these aren't fairy tales, they're true stories. Micro$oft created more millionaires than any other company in history (sorry, don't have the links on hand to back that up). And some came out during the
Today's smart tech worker should be more concerned with salary and benefits than stock options, especially with companies without an established history.
What you need to remember, as a tech worker, is that stock options are more of a benefit for the company, than for the workers. As mentioned by other posters, you need money to exercise your options. You also have to wait to be fully (or even partially) vested, and that usually takes a few years, at least. Finally, you have to hope and pray that your options are worth something when you exercise them.
For the company, on the other hand, they get to write off the options they provide. It's a huge tax boon for them. Go to Google and do a search on: "stock option taxes microsoft cisco"
As you'll see, they've avoided paying MASSIVE amounts of taxes by using stock option writeoffs. In fact, for 1999, Microsoft and Cisco didn't pay A DIME in federal taxes. Other sites agree with this story, this just happens to be one of the ones I found first.
So, that's my analysis, but hey, I'm only one guy.
I've been with my company since almost the very beginning, and as such I have a lot of options. They will be worth something if and only if the company gets bought or starts trading publicly. What do I value them at? Nothing.
Not that I don't think they're ever going to be worth anything -- on the contrary, I have a lot of faith in my company and what it does -- but I don't know for sure that they are, and even if they are, I don't even have any way of estimating how much they'll be worth.
So my strategy is to treat them like they don't exist. I don't base any financial plans on them, and I make sure that I'm being compensated fairly with a good salary and good benefits. If they ever become worth something, I'll be really happy, and that'll be like a bonus, but until them, I'm not relying on that.
- In Capitalist America, law violates YOU!
- We're a startup, and we're being very agressive about containing costs. Money saved in salary is money we can put towards product development or marketing, which will increase the [potential] value of the company and, thus, my options.
- I'm being compensated at about 80% of what I would be in a different environment, but there are other factors which IMHO more than make up for that. Even so, the money's more than enough to live comfortably.
- The work is hard to classify: I'm gaining valuable experience in many areas simultaneously, and will be more valuable when I leave the company than when I started work.
- My options are a certain percentage of company value at inception; they're 100% pegged to the company's success. If the company dives the options will be worthless; if the company completes its plan the options will be worth Real Money, more then compensating me for the lower salary.
- My labor will help influence, although not determine, the company's success. IOW, if we tank I'm not the fall guy ('less I really fuck up
;).
- We are not now, nor do we ever intend to be, publicly traded. This makes the options more risky but less volatile.
Yes, some companies can use options unethically, and employees should be much more careful about taking them as an alternative to cash compensation or benefits. But in many cases they can be win-win for employer and employee.question: is control controlled by its need to control?
answer: yes
This isn't as much "normalization" as it is "don't take so many drugs when you're designing tables."
Obviously, an option has worth. The price depends on:
Black-Scholes is a simple formula to compute the price of an option given the above numbers. Because most employees can't immediately sell their options when given them, their options are obviously worth less than unencumbered options: the price should be less than the market price. I.e. an option you can sell is worth more than an option you can't sell.
With this in mind, the article makes a couple of errors:
Given the timing of the survey, it is not surprising that stock prices of many of the respondents? firms had fallen during the previous year; the average one-year stock price return (volatility) preceding the survey went down 50%, and the average volatility was 98%.
The change in stock price (down) is not volatility: it is lower stock price. The fact that it happened implies volatility. A vol number of 98% is meaningless: 20% vol means a stock will go up or down by less than 20% two out of three years. 98% implies a distribution so non-normal (i.e. companies going out of business left and right, or growing like rabbits) as to be mere math junk.
The survey question was painfully confusing:
How much cash would your company have to offer you per option to return a fully vested stock option with seven years life remaining"? In other words, "what is that option worth to you?
Huh? I hardly understand that question, and I work on Wall Street. The rest of the aricle is equally painful.
One side note: employees may overvalue options because they know how well their company is doing. If they think it's doing well, they figure the options will be worth money. If it's imploding, they just quit and move to a new job (the survey doesn't see them.) This is classic survivorship bias.
1) Companies are not required to show an options grant in their income statement, but can show it in a footnote in their annual report. This makes the company appear to be more profitable than it really is. Motley Fool article, and part two
2) Deferred taxation. No one has to pay taxes when the option is issued, but they would if an equivalent amount of salary was paid. Business Week article, look a couple of paragraphs in.
3) Risk dilution. If a startup succeeds, the founders are going to be extremely wealthy. They'd much rather give up some of their potential gains in that situation, in exchange for a greater chance of the company succeeding. (Since their paying less salary up front.)
4) Tying the employee to the company. It's expensive to train someone to take over a position when someone leaves. It takes them a while to get familiar with what the previous person was doing.
For these reasons, issuing options can be a win-win, for both the employer and the employee. So even if employees are valuing the options appropriately, companies may still want to pay a greater value of options than they would of salary.
What I find is that, even if my stock WILL make me a single dime, the odds of me ever vesting fully, going through the legal troubles, and then actually purchasing the options is quite slim.
Most tech people are quite flighty, at least most I know are, because we tend to evaluate our positions regularly and adjust when things get stale. When job hunting, stock options are one of the last things I factor into my decision. Most of the time I can't even say that I know what my options are actually worth!
It's all about the paycheck...
Of course, don't be stupid and not sign your agreement like me (I'll do it soon, really).
Scott Adams, Dilber Author, said it best. Stock options are just like lottery tickets. They have a chance at being valuable, but most of them are worthless.
If I ever got a job that offered stock options I would flat out refuse them in favor of being paid more cold hard cash. Cash is guaranteed to be worth something. As long as you aren't being paid in Russain rubles that is.
Besides, all the money I save by using free software plus the money they pay me extra means, more hardware!
The GeekNights podcast is going strong. Listen!
Plus if there is a problem, you have all of your eggs in one basket.
Not all startups are dot coms, but a lot of businesses fail for a variety of reasons, even if it was a good idea, even if there were good people at the top, even if you yourself worked hard.
Stock options are the carrot the workers see, and it's always good management to show the carrot instead of showing the stick. You want your employees to work hard, like it was their own company. Slackers bring everyone down. So you show them ownership in the company.
It doesn't matter if the owner(s) has any intention of making the company public, if they think you might be bought out, if the market might change, or if they had good intentions from the start. The employee who takes stock options in lieu of real cash is still allowing people to gamble his rightfully due earnings.
Anyone who chooses to gamble a portion of their earnings without having enough cash left over for immediate needs and an emergency fund is stupid. So you work for a place assuming that stock options are worth about as much as the back of the sheet of paper the offer was written on.
If it helps you work hard to think you might be rewarded in the end, well, that's different. But that is the scam. Stock options are worth more to your employer as an incentive to get harder working employees than they will most likely be worth to the employee.
It's your money. You should be able to choose how it's invested. Make sure you get enough cash to handle diversifying your investments, that way a loss isn't the end of the world, and should you lose your job and your investment you aren't left with nothing. If the job doesn't offer enough cash, renegotiate or look elsewhere. Stock options have to be considered worthless until you can exercise them, it's not actually compensation until then.
Another sort of confusion that occurs with pre-IPO options is due to the fact that many people don't ask 3 simple questions when granted their optins.
1 - What was the market cap of the company at the time the options were valued?
2 - What is the current market cap of the company?
3 - How many total shares/options has the company issued?
You're allowed to ask these questions!!!
With the answers to these questions you can calculate the % of the company that you could potentially own if you exercise your options. Then you multiply this percentage times a market cap to figure out the value of your options. You can also predict the future value of your options if you have an estimate of what you expect the future market cap to be.
Not asking these questions is the same as this sort of job offer:
"We'd like to offer you a job."
ok, what will you pay me?
"50"
deal.
50 what? 50 pesos? 50 apples? 50 mules? you have no idea cause you didn't ask.
I worked at a medical startup for five years. My options got up to about $300k in value. Then the venture capitalists came in and the president/CEO of the company started taking too many cruises in the Caribbean. This is before a single dollar of income was ever earned.
Venture capitalists pressured the President/CEO to get the product out the door. The product was NOT ready.
Went as far as this: The presidents on a damn boat by Puerto Rico telling me to roll the product out. I said "It's not ready". He says "I'm the president of a multimillion dollar medical product manufacturing company, and you are second guessing me?" (Sure... multimillion.. right... I'm not sure VC investments count there buckko.)
lol.. Naturally the dumbass Venture Capitalists got their way, and our FDA medical approved robotic device FAILED on numerous patients. Darwin's theory was in full swing.
My $32,500 strike price in stock would have bought me $300,000 in stock at the height of it all. By the time the venture capitalists and Captain Ahab in the Caribbean were done, my $32,500 would have bought me $3000 worth of stock. They left the company at 1% of the value of the glory days.
My new company I work for just gives fat stock options to executives, and flips worthless little puddles of stock options to us common folk.
From our friends at The Onion:
t oc k.html
"Dot-Commers to Receive Unemployment Benefits in Form of Stock Options"
http://www.theonion.com/onion3720/dot-commers_s
What were you expecting?