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NWSI News Brief - April 2005

As June 15th nears and companies scramble to comply with FAS 123, many firms are contemplating switching from stock options to restricted shares to reduce expense. In light of this, our newsletter this month looks at these two different forms of equity compensation.

Stock Options v. Restricted Stock

As you probably know, the two most prevalent forms of incentive compensation are employee stock options and restricted stock. The mechanics of these two programs differ, but their basic objectives are essentially the same:
  1. To attract top talent while conserving cash.

  2. To compensate employees in a way that motivates them to attain the company's financial goals.

  3. To foster an ownership culture that rewards employees for success and keeps them from leaving to work for a competitor.
Although the objectives of stock options and restricted shares are identical, their impact on shareholders and employees is quite different. To understand these differences, let's begin with a basic overview of the characteristics of each type of grant:
  • Stock Option: The right to purchase the company stock at a fixed price in the future. Option grants usually vest (become exercisable) over a period of time and have an expiration date. The employee must determine when to exercise and sell to realize their value. Exercising an option triggers a taxable event. Additionally, stock options have time value and leverage.

  • Restricted Stock: A grant of company stock usually subject to a vesting schedule. Upon vesting, the employee receives the shares less the grant cost if any. Vesting automatically creates a taxable event. Restricted shares do not have time value or leverage.
Visit myStockOptions.com for a comprehensive review of these and the other forms of equity compensation. You can also test your knowledge of stock options and restricted shares using their new online quizzes.
Viewed from Different Perspectives

To compare and contrast the effectiveness of stock options and restricted stock at achieving their objectives, they need to be viewed from two different perspectives: employees and shareholders.

The Employee's Perspective

This chart quantifies the cash out value after 15 years of a grant of 10,000 options compared to a grant of 2,857 restricted shares (a 3.5 to 1 ratio of options to shares is about the industry average). Using the compound stock price growth rates of 4.6% for International Paper, 10.17% for General Mills, 12% for Pepsico, and 15.7% for American International Group this chart illustrates the wealth building power of stock options at growing companies.

The Shareholder's Perspective

This chart illustrates the costs to shareholders of the same option and restricted grants (RSPs) used in the previous example at different annual stock price increases. Unlike restricted shares that cost shareholders even if the stock price growth is flat or negative, there is no cost to shareholders for a stock option that does not increase in value. At an annual stock price increase of about 5%, options and restricted stock costs shareholders the same. The cost of stock options surpasses restricted shares at growth rates greater than 5%, but shareholders shouldn't mind the increased costs associated with rewarding employees for securing higher stock prices.

Granting restricted shares in lieu of options can reduce the number of shares required to support an equity compensation program. However, for growing companies stock options may be better at motivating and retaining key employees. In part because of the wealth building power shown in the first chart, but also because unlike restricted shares, options still serve to retain employees after they vest.

Our next newsletter scheduled for June will look at how the concepts of time value and leverage can be quantified to maximize the value of equity compensation programs.
News & Announcements

  • Delivered by a network of Certified Providers, StockOpter® Corporate Services helps companies to get the most out of their investment in equity compensation by insuring that employees understand:
    1. What they are really giving up in equity compensation if they leave the company
    2. The upside leverage in their stock option holdings
    3. The importance of their equity compensation to achieving their financial goals
    4. A framework for determining the appropriate time to exercise

  • Click here for an overview of how to attract and retain an executive clientele by providing equity compensation planning assistance.

  • A new version of StockOpter® Insight was released last month with a variety of enhancements including a revised Personal Option Profile© report that includes the client's Forfeit Value®. Licensed subscribers of StockOpter® Insight are encouraged to download and install this new version to provide their clients information to make timely and prudent diversification decisions.
  • The 2005 tax-year update of StockOpter® Pro is also now available. If you are a current user and haven't already upgraded, click here to download and install the latest version of StockOpter® Pro.
  • The StockOpter® Insight Support Center now contains a variety of new Report Templates and a Presentation Guide that will enable Insight users to establish a custom framework for determining the appropriate time to exercise.
  • Financial advisors interested in specializing in equity compensation planning can save 15% on the cost of the Certification Program from the National Board of Certified Option Advisors by ordering it from Net Worth Strategies.


Editor@networthstrategies.com •  Net Worth Strategies