Using a hypothetical set of grants, we're going to illustrate how a combination of the two most common grant types will affect an employee's "Forfeit Value®" and "Leverage". The table below represents an equity compensation portfolio that contains both stock options (ISOs and NQs) and Restricted Shares (RSPs).

Each stock option grant has an expiration date, strike price and shows the vested, unvested and total number of shares. The option values are calculated by subtracting the strike price from the current stock price (Fair Market Value or FMV) and multiplying it by the number of shares. These amounts are referred to as the "in-the-money" (ITM) value. The restricted share grants (RSPs) do not have an expiration date or a strike price and the number of shares and their value (shares X FMV) are listed as "unvested". This table does not list the specific vesting dates for each grant and the values shown are "before tax".

The information in this table is generally provided to employees in either a paper or electronic statement, but it does not tell them what they are really leaving on the table if they terminate employment (Forfeit Value®) or how stock price changes can effect the incremental value (Leverage) of their equity compensation portfolio. The concepts of Forfeit Value® and Leverage are key to an employee's understanding and appreciation of their equity compensation because they facilitate prudent decisions (this is explained below).

Combined Forfeit Value®
Most employees think that their "Forfeit Value®" is simply the value of their unvested stock options and restricted shares which in our example equates to $366,500. However, the unvested value of ones grants significantly underestimates the real "Forfeit Value®" because it doesn't take into consideration the "Time Value" of the options.

The table below calculates the "Time Value" for each of the stock option grants shown above. As was discussed in the July News Brief, stock options have a value greater than the in-the-money value. This is because options give the employee the right to buy a specified number of shares of company stock at a fixed price (strike price) for a specified period of time (up until the expiration date). Consequently, because stock prices are constantly fluctuating, an underwater option grant isn't worthless. This theoretical potential or "Time Value" is unique to stock options and can be quantified using a variety of valuation methodologies.


When an employee with outstanding equity compensation grants elects to terminate their employment they are usually given a limited period of time to exercise their vested options. However, by exercising prior to expiration they are giving up the remaining time value in their vested and unvested options and the ITM value of their unvested options (BSV = time value + ITM value). In addition to the option value, the employee is also forfeiting the value of any restricted shares. Thus, in this example the employee's combined Forfeit Value® is over $1.3 million which is nearly a million dollars more than the value of their unvested shares ($366,500).

Providing employees with their Forfeit Value® will help them to fully understand the upside potential in their grants and to make informed decisions regarding their employment.

You may know that small changes in stock price can produce large incremental changes in the value of a stock option. This is referred to as "Leverage" and its magnitude is a function of the change in stock price in relation to the strike price. For example, a stock price move from $10 to $12 is only an increase of 20%, but if the grant price was $9 then the percent increase in ITM value is 200% ($2 gain divided by a $1 initial ITM value). Consequently, small changes in stock price can result in large incremental changes (leverage) when the strike price of the option is close to the current fair market value of the stock. However, leverage is a two edged sword because a 20% decrease in stock price can result in a much more significant decrease in the ITM value.

The table below illustrates the leverage in the option portion of our hypothetical equity compensation portfolio. Starting with a current stock price of $28 the potential future price increases and decreases are calculated in 20% increments. As you can see, a 20% increase in stock price from $28 to $33.60 yields a 108% increase in the stock option value. Conversely, a 20% decrease in price results in a 54.7% decrease in option value. In fact, a 60% decrease in stock price ($14.34) results in an option value of zero.