Employee Stock Options

                         Buster Posey of the San Francisco Giants

                        Buster Posey of the San Francisco Giants

In 1960, American corporate executives earned approximately 12 times the wage of an average employee.  In 1980, the multiple had grown to 42 times the average employee.  Today, according to Mercer Human Resource Consulting, executive salaries are over 550 times an average salary. 

These surveys neglect to take into consideration one new class of professional.  One that is changing the classical connotation of "average salary." I call them EE's for elite-employees.  EE's are represented by relatively young, well-educated, and technologically elite professionals that are generally not members of corporate boards.  They don't maintain traditional executive titles, but are paid as though they do.  Many work within the internet, or one of its highly-skilled peripheral industries. Although they receive great salaries, a large portion of EE wealth is, or will be generated via incentives.

Incentives have become vital to the increase in salaries, and can make up more than half of a total compensation package.  The most popular incentive is the stock option. Closely tied to company stock performance, the financial benefit gained from this granting derivative can be substantial.  The option allows one to purchase the underlying corporate stock at greatly reduced prices, and at much later dates. If your employee stock options represent a substantial portion of your net worth, you must begin to view yourself as the CEO of your own personal stock option enterprise.  Properly managing these options is mission critical.

Stock Option Planning

Stock options can have an aura of complexity around them.  The concept of valuing something that has not yet materialized can be abrasive to logic.  This need not be. Stock options are essentially very simple. As a tool of compensation, an elite-employee simply has the option or choice to purchase company stock at a later date at pre-determined prices. This can be of great benefit to an EE.  Let's say the pre-determined price is $5, 10 years later the stock is trading at $50, there is now an inherent value of $45 for every share exercised.

Frequently, early retirement planning does not include comprehensive contingencies for how to treat appreciated stock options, and where to fit them in the larger retirement picture.  Stocks, bonds, CD's and real property planning tend to overshadow any consideration of stock options.  Today, with EE wealth becoming increasingly younger, it is imperative that concentrated attention be focused on what to do with this explosive form of compensation.

Tactical Decisions

It would be unwise to view stock options in the same manner you view stocks or mutual fund holdings. Stock options, especially if received from a start-up company, can be a riskier form of delayed compensation.  There are several key questions to answer in order to adequately plan for stock option management: 

1. Do your stock options, 401(k), and other deferred compensation make up a dangerously high percentage of your portfolio value?

2. What is the earliest and latest time you can exercise your stock options?

3. How are they affected if you are terminated? What happens upon your retirement?

After answering these and other questions, one can take a closer, forensic look at methods to

  • Generate cash flow for portfolio diversification.

  • Comply with SEC regulations concerning insider trading.

  • Minimized long-term tax burdens.

As with all financial planning, the key is to plan.  One must take into consideration all the possible outcomes, desired and undesired, in order to generate a comprehensive plan that considers both your working and retirement years.

Stocks and stock options must have an exit plan.  There must be a general schematic drawn of how, at what prices, and at what time selling becomes a serious consideration.  There must be tracking of stock option expiration dates so that in-the-money options do not expire unexercised.  There can also be substantial, yearly tax implications requiring frequent consultation with your tax professional.

Consider This

Between 2000-2001, over $1 trillion was loss in employee stock, and stock options value. Still today, over 10 million elite-employees own stock options with which they plan to pay for college tuition, or fund a large portion of their retirement.

At times, managing means doing nothing, but doing nothing doesn't translate into managing.  To simply allow stock options to sit unmonitored is not managing your wealth.  Much of the wealth loss in 2000-2001 was unnecessary.  Many of the option holders never exercised any portion of their positions, which would have effectively taken some profits off the table. As it turned out, much of the money evaporated as if it never existed.

Many of the companies that saw much of their value cut in half during this time were: AT&T, Nortel, Texas Instruments, Cisco, Intel, Yahoo...hardly small start-ups.  This points to the necessity to frequently monitor the level of percentage participation stock options play in your total net worth.  The elite-employee must have a solid plan of action.

One may consider establishing a regular program of exercising options long before retirement begins.  This can help prevent too much wealth concentration that's dependent on company stock price.  Solid stock option planning is vital to a healthy, well-balanced work and retirement life.  Paying closer attention to this element of your total compensation package must be done, and must be done today.