Pay Me in Stock Options: Manage the Options You Have, Win the Options You Want

Overview

A comprehensive guide to taking full advantage of current employee stock options plans

The phenomenon of stock options as employee compensation continues to grow in importance in more and more online and traditional businesses. In fact, an estimated eight million Americans-some eight percent of the workforce-currently hold options, in comparison with only a million workers back in 1992. Yet many people don't know how to take advantage of these ...

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Overview

A comprehensive guide to taking full advantage of current employee stock options plans

The phenomenon of stock options as employee compensation continues to grow in importance in more and more online and traditional businesses. In fact, an estimated eight million Americans-some eight percent of the workforce-currently hold options, in comparison with only a million workers back in 1992. Yet many people don't know how to take advantage of these plans and are unsure when to exercise their options or how to negotiate to get more options.

This much-needed book helps employees and management understand how options plans work in order to use them to their best advantage. Here are specific strategies on vesting schedules and tax implications, along with real-life examples from plans that readers can learn from.

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Editorial Reviews

Booknews
Over the past decade, the use of stock options as a form of employee compensation has increased significantly in the private sector. Finding that many employees are undereducated about this benefit, Curtis has created a guide explaining how to use stock options most effectively. He explains, in lay terms, the types of options; how they work and are taxed; the significance of vesting, expiration, and valuation; how to exercise options; asset allocation; the risks of options; how to avoid common mistakes; and how to negotiate for stock options. Curtis is an experienced financial editor and writer, formerly with , and CNBC.com. Annotation c. Book News, Inc., Portland, OR (booknews.com)
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Product Details

  • ISBN-13: 9780471394815
  • Publisher: Wiley
  • Publication date: 3/28/2001
  • Edition number: 1
  • Pages: 272
  • Product dimensions: 6.35 (w) x 9.32 (h) x 0.94 (d)

Meet the Author

CAROL E. CURTIS is a seasoned financial editor and writer, formerly with Forbes, Business Week, and CNBC.com. She is currently working on Wall Street as a Vice President of a bank brokerage. Curtis has also worked on special projects for large financial services firms including Oppenheimer & Co.

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Read an Excerpt

We Have Seen the Future, and It Is Stock Options



Mark H. Edwards is one of the most seasoned compensation consultants in the business, with over 20 years of experience and a degree from Massachusetts Institute of Technology's Sloan School of Management. Seven years ago, Edwards left his comfortable old-economy existence behind to found iQuantic, a rising consulting firm serving the new economy. From his office in San Francisco's newly fashionable warehouse district, Edwards has built a thriving practice by advising companies on stock option grants. With hundreds of clients in every nook and cranny of the technology business, Edwards has become perhaps the most experienced observer of how stock options are transforming the high-tech business culture.

Edwards, 47, also walks the walk. His own company--private, but set to go public by 2002--embodies his own vision of the future. In addition to a salary, every employee has stock options, ranging from 2,500 shares at the lowest level to over 200,000 for senior management. The grant price is less than $1.

So far, Edwards has given away over 15 percent of iQuantic via options, and he expects to give away an additional 5 to 10 percent over the next year. The startling thing is not so much that Edwards has already given up so much of his company--it is that he is still losing employees, he says, to companies whose options packages are even more generous.

Welcome to the future of compensation. Despite recent market volatility, in no other place and at no other time has so much wealth been amassed by workers in a single industry. And the driver of this wealth creation is stock option compensation. According to iQuantic's research, more than 140,000 high-tech millionaires were created in 1999, more than triple the number created in 1998, and more than a sevenfold increase from 1997. And the good news is that this money is not just going to a select few executives at the top, as it has in the past. Over 100,000 high-tech employees below the level of vice president became stock option millionaires between 1994 and 1999.

The presence of stock option wealth in the new economy is so pervasive that old-economy companies must adapt or die. According to the National Center for Employee Ownership (NCEO), close to 10 million employees now receive stock options. Over 90 percent of large public companies offer stock options. And in Silicon Valley, the birthplace of broad-based options, virtually every single start-up offers options as a major form of compensation.

Options were first used in the 1940s and 1950s as a bonus for key executives. Until the 1980s, and the rise of Silicon Valley, they were largely limited to a firm's top management. As recently as 10 years ago, according to the NCEO, only 1 million employees received stock options.

What happened to spur this phenomenal growth and create leading-edge entrepreneurs like Edwards? While stock options offer significant benefits to the employee, a key factor is their benefit to the employer. A company that issues stock options gets favorable tax and accounting benefits. Under present rules, the value of stock options is normally not recognized on the books of a corporation--it appears instead as a footnote on the financial statements. The value is charged against income only when the options are exercised. And in the case of the most popular type of option for nonmanagement employees, the so-called non-qualified stock option, the charges are considered a business expense that can lower a company's tax bill.

Still another company benefit is tied directly to the rise of Silicon Valley start-up firms. All these companies use stock options for the simple reason that they are all short on cash and have no profits, so their ability to pay high salaries is limited. Instead, they offer options as a promise of future gains based directly on the success of the company. This widespread use of equity ownership is a distinguishing characteristic of new-economy companies.

Firms of all types have also found that stock options increase worker loyalty and improve morale. This is in part because in most cases options need to be vested before they can be exercised. This can take up to four years, sometimes longer, so employees need to stay at least that long in order to fully profit from them. Options improve morale and spur productivity because sharing in the ownership of a company makes employees think like managers, and managers think like owners. "Options are the best compensation mechanism we have for getting managers to act in ways that insure the long-term success of their companies," said Brian J. Hall recently in the Harvard Business Review.

However, stock option growth has now taken on a life of its own. The recent market downdraft notwithstanding, success stories of options millionaires still abound. A peak may have been reached in mid-1999, when the July 5 cover of Newsweek proclaimed the "Whine of 1999"--Everyone's getting rich but me! A main reason, according to Adam Bryant of Newsweek, was the phenomenon of the instant millionaire--Silicon Valley optionaires who cashed out big when their dot-coms went public.

Even in the face of the recent dot-com shakeout, there is a virtual war for talent going on in many technology firms, allowing workers to move from job to job as they search for the best options package. And top management isn't being left out: According to Pearl Meyer & Partners, a New York City-based compensation consulting firm, options now make up more than two-thirds of the average chief executive's pay.

"Stock options are such a big thing that they may actually be impacting the statistics that are used to measure the overall economy," contends David Wray, head of the Chicago-based Profit Sharing Council. Although research has yet to confirm it, Wray believes that the recent lack of wage inflation is partly due to the replacement of a regular paycheck with stock options. In the near future, Wray believes, one-half of all compensation will be stock based.

Meanwhile, stock options and the new economy have become so intertwined that it is hard to envision one without the other. And Edwards argues convincingly that it takes more than money to create that link. In a paper on stock options and the new economy, Edwards points out that employees whom Peter Drucker first called "knowledge workers" back in the 1950s are attracted by a company's culture--its vision, leadership, and a whole host of characteristics that people may have difficulty describing, but know when they see or feel them:

What has come to define culture for many skilled workers is an organization's recognition of the wealth created by its employees, and the extent to which it shares that wealth with them. So while the high-tech culture of Silicon Valley is set apart from the Old Economy by things like a high ratio of pool tables to employees, boxes of doggie biscuits in drawers, and even (increasingly starched) khakis, in the minds of many it is defined by the availability of stock options.

Is this a good thing, and what does it mean for you? We have seen that the tax treatment of options, and the fact that options are a handy substitute for cash, makes them a very good thing for companies. We have also witnessed an unprecedented amount of wealth creation, in terms of the sheer number of new high-tech millionaires.

But the boom has occurred in the midst of record economic prosperity. So much of the wealth that has been created exists merely on paper, waiting to be cashed in. What happens in the event of an ongoing economic downturn? We caught a glimpse of this during the recent dot-com meltdown. As the tech-heavy Nasdaq plunged, unvested, unexercised options were dragged down along with it. While morale plummeted at many firms, there was no mass exit from the market, or from high-tech companies. Still, one report said that as many as one-third of the San Francisco Bay area companies that had gone public during a recent 16-month period were trading at prices below their offering price, making their options worthless.

The bright side is that companies appear to be adapting to make stock options better able to withstand a volatile market or an economic downturn. Many companies are resetting their options by issuing new grants at lower prices. One twist is to shorten the vesting period via performance-accelerated stock options (PASOs), which allow options to vest faster, pinning them to a performance goal such as share price growth or a target revenue level.

Repricing, which involves issuing options at a lower price so they will no longer be underwater, used to be a popular tool for handling a sagging stock price. But new rules make repricing expensive, so companies are developing other means of dealing with underwater options, including the issuance of more options at a lower price (so-called resetting) to make up for any losses during market downturns.

Still, as Edwards and other experts point out, one of the most valuable ways to make stock options a meaningful tool for retaining employees is communication: "The best position a company can take to get the full value out of its stock option program is to communicate, fully and effectively, what the grant means to employees," he says.

That's where this book comes in. If knowledge is power, then knowledge of stock options is the power to create wealth--and it can make or break the effectiveness of any options grant.

Despite the complexity of options at every level, companies have generally done a poor job of educating their employees. While top executives get free financial planning, including the services of a stock options expert who can help them value, exercise, and invest the proceeds from their stock options, most employees are left high and dry with their stock options grants, often without even the most basic information, such as what kind of options they have.

Valuing stock options is no piece of cake. Neither is exercising them, or figuring out how they work, what taxes are owed, what risks to avoid, and what to do with the proceeds. Even before being hired, knowing how to negotiate for stock options can make a big difference in how generous an options package you receive. But to date, there have been no manuals on how to do this effectively.

Even so, the new economy is pushing employees to new levels of sophistication in terms of understanding their compensation. As stock options take their place alongside 401( k) plans and Individual Retirement Accounts (IRAs) as tools for wealth building, employees will need to become much more informed decision makers about how they are compensated.

The goal of this book is to make you an informed decision maker about stock options--getting them, making the most of them, and investing the proceeds wisely.

But before classes begin, we'd like to take you on a brief journey through Optionsland. By recounting actual case histories of entrepreneurs who have shaped our options culture (and become millionaires--or billionaires--in the process), we hope to provide the inspiration and motivation you will need to become a diligent student of stock options.

They--like you--are part of the new pay paradigm, in which smart people will demand a share of the wealth they create.

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Table of Contents

Preface.

Acknowledgments.

THE RISE OF STOCK OPTIONS.

We Have Seen the Future, and It Is Stock Options.

The New Corporate Hero.

STOCK OPTIONS IN 10 EASY LESSONS.

Lesson 1: Stock Option Basics.

Lesson 2: Different Types of Options, How They Work, and How They Are Taxed?

Lesson 3: Vesting, Expiration, and Valuation.

Lesson 4: Exercising Your Options.

Lesson 5: What Should You Do with the Proceeds?

Lesson 6: A Short Course in Asset Allocation.

Lesson 7: The Risks of Options.

Lesson 8: Options Overseas.

Lessson 9: Other Types of Stock-Based Compensation.

Lesson 10: Avoiding Common Mistakes.

How to Negotiate for Stock Options.

Frequently Asked Questions.

Appendix A: Risk Tolerance Questionnaire.

Appendix B: Selected Stock Option-Related Web Sites.

Notes.

Glossary.

Index.

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