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Equity Compensation Education Brief |
About This Newsletter
Welcome to the Equity Compensation Education Brief. This newsletter is dedicated to helping companies maximize the value of their equity compensation programs to both participants and shareholders. If you do not want to continue to
receive this publication you can unsubscribe using the link at the bottom of this page.
Forfeit Value and Why is it Important
If you read the newly required Compensation Discussion and Analysis section of proxy statements (DEF 14A) issued by public companies you will almost always see retention and motivation of key personnel as the rationale for shareholder
approval of a long term incentive program (primarily stock options and restricted stock). The power of these programs to retain and motivate is a function of both the present and potential future value that employees perceive in their
stock and option holdings. This article focuses on the retention power of stock and options as expressed by perceived Forfeit Value which is the current value an employee would sacrifice if they left the company for reasons
other than retirement.
The Forfeit Values of restricted stock and stock options differ significantly from each other as follows:
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For restricted stock, the Forfeit Value is simply the current market value of these unvested shares. Upon vesting, the Forfeit Value of these shares becomes zero because the employee can now sell them.
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Stock options have two value elements that affect their Forfeit Value: 1) the intrinsic value which is the difference between the current market value and the exercise (strike) price, and 2) the value arising from the potential that the
stock price will increase prior to expiration of the option referred to as "time value". Unlike the Forfeit Value of restricted stock, the Forfeit Value of stock options includes both unvested and vested shares.
Employee perception of their Forfeit Value is important to both the employee and the employer. This is particularly critical where options are being used as a key component of the long term incentive program. Research conducted by
business school professors at the University of Illinois and Michigan State University presents compelling evidence that:
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On average, employees underestimate the Forfeit Value of their option holdings by 60%.
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This underestimation can be substantially eliminated with a personalized education program that explains the concepts and provides them with their specific Forfeit Value.
Table 1 below shows the in-the-money (ITM) value of a set of vested and unvested employee stock options:
Typically, employees will think their Forfeit Value is just the ITM value of their unvested options. In the option portfolio above this is only $39,725. However, when you take into consideration the time value, which is also
forfeited upon termination, the picture is quite different. In table 2 we use the widely accepted Black-Scholes formula to estimate the current value (BSV) of the options and the time value component of the BSV. Note that the difference
between the BSV and Time Value is the ITM value shown in table 1.
The Forfeit Value can be viewed as the opportunity cost associated with leaving the company. This Forfeit Value? includes not only the ITM value of the unvested options, but also their Time Value. As a result, the Forfeit Value? is the
sum of the remaining Time Value of the vested options and the full Black-Scholes Value (e.g., ITMV + TV) of the unvested options. In this case, $59,367 (TV of vested) + $99,121 (BSV of unvested) = $158,489. This is almost four times the
$39,725 ITM value of the unvested options.
The research mentioned above and field experience indicates that there are two critical elements to gaining employee understanding and acceptance of this full value way of thinking about Forfeit Value?:
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They must receive education on the concepts discussed above. Although this is probably best accomplished in a face to face setting, it can also be achieved by other modalities.
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At the same time that they are exposed to the concepts they should be given their own tables so they can personalize their understanding. Providing them with their own Forfeit Value further fortifies acceptance and retention of the
calculated number or something close to it.
High value personnel are constantly and heavily recruited by other companies and the search firms that represent them. Although the allure of an outside offer may be in the position being offered, few executives will be willing to take a
cut in compensation in order to secure a new position. Thus, their perceived Forfeit Value will be a critical factor in the decision making process. In most cases the company recruiting them will find it difficult to match the Forfeit
Value of options that have been granted over a period of several years. To give you an idea of how important employee perceptions of their Forfeit Value might be to the long term success of a company here is a hypothetical illustration
entitled:
"A Tale of Two Companies."
Additional information about Forfeit Value including details on the research cited above can be found at
www.EquityCompensationEducation.com. A great source of general information on the treatment of stock options upon termination can be found in the "Job Events" department of
myStockOptions.com. An example of a FAQ from
myStockOptions.com on this topic is:
Q: What happens if I terminate my employment before an option grant is fully vested?
A: If your option was granted with a graded vesting schedule, you are allowed to exercise the vested portion of the option grant, but most commonly you forfeit the remainder... |
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Directory of Equity Compensation Planning Specialists
As an equity compensation professional you are well aware that employees often need assistance to understand and make prudent decisions with their stock and option grants. However, obtaining assistance is problematic for a couple of
reasons. First, companies are generally precluded for legal reasons from helping their employees make equity compensation decisions. And secondly, finding a financial advisor that is sufficiently qualified and experienced to provide
equity compensation planning assistance is like finding a needle in a haystack because of the 250,000+ advisors in the industry, only a small fraction of them specialize in this complex field.
For these reasons Net Worth Strategies has developed an online directory that serves to connect individuals who receive equity compensation with financial advisors who specialize in this form of planning. The
Directory of Equity Compensation Planning Specialists enables individuals with equity compensation holdings to search for advisors by state. There is no formal certification for stock option planning, so the directory contains a
list of financial advisors who are licensed users of the industry's leading equity compensation planning tools; StockOpter? Insight and StockOpter? Pro.
These advisors have not been reviewed by NWSI for their proficiency in the field of equity compensation planning so users of this directory are encouraged to thoroughly research the advisor and firm before engaging in any planning or
investment services. However, this directory is a unique and valuable resource for stock plan participants that can serve as a starting point for securing an advisor with the expertise to address complex diversification, taxation and
cash-flow issues.
The Directory of Equity Compensation Planning Specialists can be found at:
www.NetWorthStrategies.com. |
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Ongoing Research on Employee Perceived Values
As was mentioned in the
Previous Edition of this news brief and in the Forfeit Value article above,
research from professors at the University of Illinois and Michigan State found that professionals underestimate the value of their employee stock options relative to the Black Scholes value by an average of 60%. Of greater importance
however, this research noted that this Cost-Value Gap can be eliminated by providing employees with personalized education of the "time value" of their options.
These findings were used as the basis of an online survey conducted from September 6th to September 19, 2006 by the
National Center of Employee Ownership (NCEO) and sponsored by Ameriprise Financial and Net Worth Strategies. The purpose of this research was to "explore the beliefs of companies about the gap between the perceived value of options
(in the eyes of employees) and their actual value, as well as companies' level of interest in closing this gap through education. Two versions of the survey were administered by the NCEO: one for individuals at companies with stock option
plans and a second for service providers to such companies. The two versions differed only to gather company demographic information including: industry, ownership (public/private), number of employees, percentage of option holders, etc.
A total of 132 responses were collected (77 Companies and 55 Service Providers) yielding the following results:
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53% of the responding companies provide no stock option training to their employees
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Of these companies, only 22% feel their option programs are "Very Effective" at retaining executives
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70% of both company and service provider respondents indicated that the university research on the Cost-Value Gap cited above "seem credible"
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77% of company respondents believe that the research results are "somewhat" or "highly" likely be duplicated at their companies
The
Executive Summary and the
Full Report contains additional findings such as which group (i.e. HR Executives, Corporate Officers, Institutional Investors, etc.) would most likely be interested in reducing the cost-value gap, and what factors (i.e. motivation,
retention, responsibility to shareholders, etc.) have the greatest effect on motivating companies to undertake stock option education. For more information on the results of this survey contact
Loren Rodgers of the NCEO at 510-208-1307.
Resources and Offerings
For more information regarding any of the resources or offerings described below contact
at 877-728-5964.
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Executive White Paper:
Maximizing the Perceived Value of Equity Compensation. This document was designed to help stock plan professionals build a business case for personalized equity compensation education based on 1) improved retention of key personnel,
2) increased motivation of key personnel and alignment with corporate objectives, and 3) responsibility to shareholders for the full value from their investment in equity compensation.
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Cost-Value Gap Assessment: Are you curious about the magnitude of the gap between the cost and the perceived value of your equity compensation program? If so, Net Worth Strategies has low cost and turn-key approach to allow you to
determine the size of the cost-value gap at your company.
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Forfeit Value Analysis: Do your key employees have a sufficient amount of Forfeit Value to facilitate retention. Granted these employees need to have this number in their heads to maximize the retention power of your equity
compensation program, but is this number enough? If you want to be sure that your key employees have commensurate Forfeit Values with their level of importance, we offer this service.
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StockOpter? Personalized Education: A turn-key offering that maximizes the effectiveness of any equity compensation program by providing participants with the
5 things they need to know about their stock and option grants.
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