Employee stock option grants provide great potential to create chucks of wealth with the leverage they provide. Conversely, wealth can vaporize just as quickly in a falling market. Don’t get caught watching your big payday vanish like the fearful employees, of the well-known company Google, did in 2008.
Google Stock Option Grant Story
I use Google as an example because they are well known by nearly everyone, perceived to be a great company, and a great investment, over the past decade. Despite all the wonders and greatness of Google, they were not able to escape the market collapse of 2008, and the resulting number of underwater stock options held by employees at the time was staggering! Google reported in a January 2009 press release that 85% of workers’ stock options were underwater; fortunately for their workers, they also announced an option exchange program in which employees were able to exchange one underwater option for a new option at the March 2, 2009 closing price. It was a controversial maneuver and one that should not be counted on by individuals holding large positions of company stock options in the future. Re-pricing to a lower exercise price effectively dilutes non-employee shareholders in the company. For an executive or member of the board of directors, a re-pricing decision is sure to draw the ire of their shareholders being diluted.
Leverage, Leverage, Leverage
Most equity compensated employees are granted options annually and, consequently, their option portfolio is comprised of various exercise prices. As the stock price increases, the value of the option portfolio can increase at a greater rate as the price appreciates above the various exercise prices of each option grant. Additionally, as the price further increases, the cost associated with exercising said options are less relative to the overall option portfolio value. These mechanics are great for the ride up but can be greatly devastating on the way down as an option grant can lose its entire intrinsic value as stock price falls below the exercise price as seen in the Google example during the 2008 downturn. If you’re lucky you’ve got enough time to maturity to mount a potential comeback to avoid rendering your grant worthless.
How to Avoid Getting Googled
Of course, we don’t recommend relying on luck or a company bailing you out with a re-pricing in the Google example. It’s always best to devise a well thought out strategy when dealing with equity compensation such as stock options. A good strategy will consist of monitoring price targets, diversifying when advantageous, and of course planning for the tax ramifications of eventual stock exercises. With stock markets currently near all time highs, it’s a great time to revisit your existing strategy or perhaps implement a strategy if you’ve not done so yet.