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?"

Comments

$0

[magic]

I value my stock options at $0, which is what they are worth until the company is publicly traded and your restriction period is lifted.

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

Re:$0

[taniwha]

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.

Yes but most public companies will do the single transaction exercise&sell thing with a broker for you (but they are required to do some withholding on it and you wont be able to claim capital gains)

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.

ONLY if you exercise and don't sell after yyour grant. There are 2 ways to avoid this 1) exercise your options into escrow the day you get the grant - that way they are worth what you pay for them and owe no capital gains on them untill you sell them (or can lock in long term capital gains - this is a particularly goodd idea if you are getting penny/nickel stock as a company founder or very early employee), or 2) exercise&sell - in one transaction, that way you have the cash to pay the tax on the capital gain (but you pay the higher short term rate) - be vary carefull if you are exercising more than about $100k in a year - you may also be subject to AMT anyway because it tends to wipe out your traditional deductions (house, property tax, childcare etc) - see a profesional - don't wait 'till the end of the year and pay the penalty

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.

This is true - the way it works is that the people who fund a startup (that leads to your paycheck) get preferential shares - if a company goes public these get converted to ordinary shares, if it gets wound up they get converted first at a fixed rate, if the company gets sold for less than the value of the pref. shares then nothing is left over for ordinary share holders

A total joke.

[vitaflo]

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.

I'm working for options

[legLess]

I'm working for stock options, and it's a good deal for me and my employer. Here's why:

1. 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.
2. 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.
3. 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.
4. 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.
5. 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 ;).
6. 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

A critque

[Gorobei]

First, a quick recap recap as to what an option is: it is the right, but not the obligation, to buy stock at an agreed upon price (the strike price) some time in the future. Depending on the type of option, there may be a single date at which the owner must choose to exercise (buy at the price) or there may be a period in which the choice can be made (an American, rather than European, option.)

Obviously, an option has worth. The price depends on:

• The current price of the company's stock (the higher the better).
• The strike price of the option (the price you get to buy at, the lower the better)
• The volatility of the stock (how much it bounces up and down, the more bounciness, the better.)
• The time to expiration (the longer you have until you must buy or pass, the better.)
• Interest rates (ignore these, they aren't really important.)

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.