Google Offers Innovative Stock Option Scheme

PreacherTom writes "In a bid to breathe new life into scandal-tainted stock options, Google plans to give employees a novel method of cashing in their options. The search giant will let employees sell their vested stock options to selected financial institutions in an auction marketplace it's setting up with Morgan Stanley. In the last year, employees and employers have been 'punished' by the IRS with new rules requiring options to show up as an expense on the bottom line. This has caused companies to tone down the granting of options. Google's move could once more significantly change compensation for employees in many industries, including tech." The new plan is intended only for Google employees, not executives. Google's motive is not saving money but rather continuing to retain employees with stock incentives in the face of considerable price volatility.

Comments

Or, you know...

[TheGreek]

...maybe they could just pay them more.

Re:Or, you know...

[nelsonal]

Well essentially they are, as most people under value their stock options. In Google's case viewing a 2 year option at intrinsic value is a substantial undervaluation. To give you some idea an option with a strike price of $600 (well above that of any employee stock options) is worth about $70/share, but good luck convincing the employees who got a grant with a strike of $500 or more.

Re:Or, you know...

[flagg9483]

"...maybe they could just pay them more." But then you're missing the whole point on incentive based compensation. Giving stock options provides an incentive to work harder and improve the performance of the company. If you've ever been a manager you'd know that giving the same old raise every year does little to motivate employees, but when workers see a direct correlation between their effort and organization performance they can become great employees and have higher job satisfaction.

Re:Or, you know...

[flagg9483]

You obviously didn't read the article. The whole point of the Google plan is that it provides employees an opportunity to cash in the value of option and opt out of the equity investment should they so desire. It also still gives them the chance to hold company stock if they want to take the investment risk which is what Google would like. As a Chartered Accountant and auditor I'm quite familiar with Enron and the impact its had on my industry. In the Enron collapse there were two main problem caused by stock options. First, at Enron, executives who had significant share holdings were motivated to increase their own personal wealth at the expense of shareholders and employees. As the article states, this is for employees and not executives, so it shouldn't interfere with management's stewardship function. Second, employees lost money because they didnt properly diversify their portfolio's and because the proper regulations weren't in place to allow and insure investment risks were mitigated. The Google plan mitigates the risk of employees holding too much of the company's stock by providing them a quick cash alternative. It looks very much like Google is sacrificing some of the benefit of traditional incentive based compensation by giving employees an escape route. Employees win.

Tax avoidance is innovation now?

[Timesprout]

Well everything Google does is innovative round here i guess. I thought the main reason stock options were out of favour was too many people took them in lieu of full salaries back in the boom days and ended up with nada after working their testicles off.

Re:Tax avoidance is innovation now?

[bmac83]

No, stock options are out of favor because they have previously provided an excellent way to compensate employees without such a huge negative impact on the income statement. As public scrutiny and regulations tighten, the bad behaviors of various companies are coming to light.

This really is a big deal. Normally, your employee stock options are tied to you and cannot be sold. Since you have less "options," the value of these to employees is quite a bit less than normal stock options to normal investors. These limits are in place for a reason: you want to exercise the options as late as possible to capture the maximum benefit (especially when you predict the company will do great in the future), and you can't exercise if you quit your job and walk away without those limited options.

Giving up on stock options because they didn't make people money for a period of time would be irrational. The whole point of stock options is to provide incentive to employees to stay at the company (to be able to exercise, or even just to receive more options) and to work really hard so the company does well. While employees who worked for stock options during that time were victims of an economic swing, options did no more than what they were supposed to do: employees of the ultimately successful companies became rich just as they imagined when they accepted such a job offer.

And, if you read the article, you will see this quote:

But it does offer a different--and possibly more accurate--way to value stock options, an area of great debate even now, nearly a year after options were required to be logged as expenses on a company's books.

This is not about tax avoidance. It's about providing attractive compensation to employees. Google may actually over-report compensation expense due to the increased value and precision of these options.

Black-Scholes

[BrotherZeoff]

http://en.wikipedia.org/wiki/Black-Scholes

This is the main theoretical method for option valuation.

The formula was derived by Fischer Black and Myron Scholes and published in 1973. They built on earlier research by Edward O. Thorp, Paul Samuelson, and Robert C. Merton. The fundamental insight of Black and Scholes is that the option is implicitly priced if the stock is traded. Merton and Scholes received the 1997 Nobel Prize in Economics for this and related work; Black was ineligible, having died in 1995.

I think it's really cool what Google is doing here - get some actual values which can then be compared to the Black-Scholes values. Doesn't it seem possible that Google will be willing to auction off other firms' options as well, if this catches on?

WOw, what a neat idea

[Xemu]

The search giant will let employees sell their vested stock options to selected financial institutions in an auction marketplace

That's pure genius! Perhaps we could have professionals bidding on this market place and call them "auction brokers" and we can then have all these professionals work in a place we call the "auction exchange". We could then allow any company that meets certain standards to hold auctions on this market place and code different company auctions with a letter code we can call "auction ticker".
Imagine the possibilities.

Re:WOw, what a neat idea

[mre5565]

You and people who modded you up are laughing because you fail to understand.

There are basically two types of options: stock option grants to employees, and derivatve options sold by options exchanges. The latter come in the form of puts and calls. A person who buys a put option is buying the right to sell 100 shares of a specified company to seller of the put at a specific price. A person who buys a call option is buying the right to buy 100 shares of a company from the option seller at a specific price. One buys a put option if he expects the price of the stock to drop. One buys a call option if he expects the price of the stock to rise. One who buys a call or put can sell it later if he wants. The call or put usually has a short life time (a few months usually), and expires if not "exercised" (i.e. the owner of the call buys the stock, and the owner of the put sells the stock).

Employee stock options are basically call options that the company has sold to the employees for zero dollars (well technically the company has bartered the options to the employee in exchange for their labor). However, employees cannot sell these options on an open market. All they can do is "exercise" (i.e. "call the option" by buying the stock from their employer). At least, not until Google.

Why would an employee want to do this? Because sometimes call option prices have built into them a future expectation of price appreciation. It is possible for the employee's call option to be sold for more than the current market value of company's stock. And with GOOG's rise over since its IPO, many buyers of GOOG call options would be willing to make that bet. An employee can thus bank GOOG's future appreciation now, and diversify now (or he can use the proceeds to buy more GOOG). Another example would be employees that have "under water" options; options that have a strike price higher than the current market value of the GOOG. Without Google's new options market for employee, such options are worthless. Whereas, with an options market, such options might be worth something, even it is just a few dollars per option. There are lots of employees of former high flyers like Sun that would be interested in such a market, because they hold options with strikes of $50 per share or more.

So this is a good, employee friendly, thing. Yes it is an obvious idea, but keep in mind that the investment industry is very conservative, and it sometimes requires people like the Google founders to question conventional approaches.

Re:WOw, what a neat idea

[aminorex]

Its also good for Google, because they can bid on the options themselves, which means they reduce the size of the float, and do so by booking treasury shares at par (usually 0.01$ or 1.00$) instead of booking them at market prices. It's also good for Google shareholders if Google is reducing the size of the float. Frankly, I think it's not brilliant but a good, sound idea, a win-win-win idea. (Assuming the employees make good decisions.)

Nice try google...

[danpsmith]

Google's move could once more significantly change compensation for employees in many industries, including tech.

Nice try Google, I mean you can try to change compensation for tech employees but in the end, as the saying goes: The bubble-era vision of a Utopian Internet is dented and dirty... The Lexus has collided with the olive tree, and its crumpled hulk spins in a ditch as the orchard smolders.

Re:Sorry, I call BS

[Joe Decker]

I'm not sure I understand your dismissal. It sounds to me like Google is not trying to avoid expensing options. It sounds to me like Google is using the method they're proposing, much as Coca-Cola already does, do determine a fair market price for the options, a step which makes the determination of the value of the expense to be included on their books a lot more direct. So, where's your beef?

The employees still lose...

[madhatter256]

Giving them the option to sell the stock publicly is alright. However, it is still an unsecure benefit. Companies today are giving their employees more riskier benefits. Its like giving lottery tickets as a christmas gift. This stock option is similar to that. What if now Googles stock starts to drop and stays well below the price it is now? Then the employees have lost a lot of money in that investment and end up selling at a low price to institutions like Morgan Stanley, etc. Who can then turn around and demand employee layoffs with the low stock price and threaten takeover if those instutions have a controlling stake in the company.

  This is a growing trend for companies nowadays, where they give their employees less benefits (thus decreasing company loyalty, and it is why you have rampant corporate espionage today) while execs keep giving themeselves cash-benefits and an 'fallout shelter' incase of a financial collapse of the company (ie Enron). This isn't a gift, its a slap in the face to the employee! It purely says, "hey! we're giving you the option of selling the stock if and when it starts to go down! You know what they say when stocks start dropping for a company, right? Layoffs! So, having this option is actually neccesary for when we lay you off because you will need all the money you can get from that stock to feed you family. Oh but wait, don't forget the dividends tax! Sure your all the stock you own might be worth $5,000 but with it being that small you pay a high dividend-tax when you sell thanks to Bush passing that law in 2001! Have a nice day!"

Where have ethics gone? Corporate America used to have it but it lost it somewhere in mid 90s.

Re:Nobody is punished

[larkost]

I agree with you in general principal, but options but a lot of head scratching into what the value is. Here is the basic problem:

When a company grants someone an option, they are giving that person the right to purchase a set amount of stock (from the stock that the company still owns) at a set price (usually tied to the the price of the stock at the close of the market on the day that the option is granted). There are usually then rules associated with the option about when they can exercise the option (use the option to buy stock), and how long they have to hold the stock after purchase before selling it (making money with it).

So if Company A grants 100 options to Bob Smith at $5 less than today's price (lets say $45) without any restrictions, then Bob can instantly pay $4,000 of his own money to buy all of the options he is entitled to, and then turn around and sell the stock to someone else for $4,500 (market value). In this case Bob has gotten $500 extra out of the deal (minus short-term capital investment taxes), and the company has traded $4,500 worth of stock for $4,000 of Bob's money. The $500 that seems to be missing from this equation comes from whomever buys the stock from Bob. In this case it is fairly clear that the company should expense $500, since they got $500 less from selling to Bob then they would have on the regular market.

If we look at the same example, but say that the option had a one month holding time (meaning that Bob has to hold the stock for one month before selling it), and during that month the stock goes to $80 a share, and Bob immediately sells, then the math is a bit less sure. Should the company expense the $500 that it could have made at the beginning, or the $4,000 that Bob has made out of the deal?

And in a third example: what if Bob does not instantly cash in the option, but waits and in that time the stock drops to $35 a share. In this case it does not make any sense for Bob to spend $40 a share to get what he can get for $35 a share elsewhere, so he never uses the option. Should the company have some sort of expense for this? Remember, nothing but a promise to offer to sell at a specific price has ever changed hands. In this case Bob neither gains nor looses money.

And there are a lot more examples, and we have not even brought up the subject of back-dataing, which opens things up wide for abuse. (note: back-dataing has a few places where it is relevant, such as when a company promises options, but then does not get around to the actual granting for a while... this is a grey area).