As you know, Microsoft announced sweeping changes to their equity compensation program this week. This announcement served to reinforce our belief that equity compensation programs will continue to evolve which represents a huge opportunity for advisors who can help clients to make prudent and timely decisions.

Case in point, Microsoft's new program allows employees to convert their options to company stock. Consider the following example: an employee is offered $2.00 for each option with a strike price of $33 assuming the current stock price is $25 (this is roughly the example Microsoft used in the email announcing the new plan). What should they do? Of course, it all depends on what they think will happen to Microsoft stock in the future as well as the return they expect from cashing out now.

In deciding whether or not to sell their options, Microsoft employees will need help to analyze the trade-offs. Each case will be unique due to varying grant and assumption data, but the following analysis, created using StockOpter®, is a useful illustration for someone faced with such a decision.

Using the Microsoft example, and assuming the option expires in 2008, we've illustrated 3 different scenarios in the chart below. The case titled "Sell options and reinvest after-tax cash flow" shows the value over time for cashing out the options at $2.00 per share and reinvesting the proceeds at 8%. The other two lines illustrate holding the options until expiration, selling, and reinvesting the proceeds at the same 8%. One case assumes the price of Microsoft stock increases 6% per year ($34.12 at exercise in 2008); the other assumes a stock price increase of 8% ($37.47 at exercise in 2008).

In this analysis, the required return for Microsoft stock in order for this employee to be indifferent between holding the options and, taking the buy-out alternative is approximately 7%. Thus, if Microsoft appreciates at a compound rate greater than 7%, the client would be better off holding the options.