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Google Offers Innovative Stock Option Scheme 84

Posted by kdawson
from the sweat-equity dept.
PreacherTom writes "In a bid to breathe new life into scandal-tainted stock options, Google plans to give employees a novel method of cashing in their options. The search giant will let employees sell their vested stock options to selected financial institutions in an auction marketplace it's setting up with Morgan Stanley. In the last year, employees and employers have been 'punished' by the IRS with new rules requiring options to show up as an expense on the bottom line. This has caused companies to tone down the granting of options. Google's move could once more significantly change compensation for employees in many industries, including tech." The new plan is intended only for Google employees, not executives. Google's motive is not saving money but rather continuing to retain employees with stock incentives in the face of considerable price volatility.
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Google Offers Innovative Stock Option Scheme

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  • by TheGreek (2403) on Wednesday December 13, 2006 @10:23AM (#17222378)
    ...maybe they could just pay them more.
    • Re:Or, you know... (Score:4, Insightful)

      by nelsonal (549144) on Wednesday December 13, 2006 @10:36AM (#17222516) Journal
      Well essentially they are, as most people under value their stock options. In Google's case viewing a 2 year option at intrinsic value is a substantial undervaluation. To give you some idea an option with a strike price of $600 (well above that of any employee stock options) is worth about $70/share, but good luck convincing the employees who got a grant with a strike of $500 or more.
      • by AoT (107216)
        Which is why "Google's motive is not saving money but rather continuing to retain employees with stock incentives in the face of considerable price volatility." is a bunch of nonsense. Google (possibly) found a novel way to increase the salaries of their employee with out having to pay them more.

        There isn't anything wrong with saving money, especially when it can be done in a way that benefits the company and the employee.
        • by durdur (252098)
          It also allows them to get some benefit even from options that are at their strike price or below. It is certainly innovative, but fundamentally I think this is also a way to persuade employees to sign on to or continue in jobs that will come with options priced at bubble levels. I don't think Google is going to $5000 a share anytime soon. But there are startups and early stage companies where 10x appreciation over several years is a reasonable possibility. Their challenge now is to keep people from walking
      • by xenocide2 (231786)
        I'm a bit confused. The going rate for Google stock is currently 500 dollars. You're saying an option with a strike price 100 dollars over that is worth nearly 70? Am I missing something, like the options expire two years from today?
        • by nelsonal (549144)
          Yeah an option to buy the stock $100 over the current price expiring 2 years from today is worth $70/share.
          • by Discopete (316823)
            You are mistaking standard equity options with Employee Compensation Stock Plan Options.

            Compensation Plan Options are not normally transferrable and are nothing more than a contact between the optionee and the company in which the company is willing to sell the optionee shares at a fixed price for 'X' number of years. The stock to back this option comes directly from the companys treasury, not the functional open market. Thus a Compensation Stock option is barely worth the paper it's printed on (assuming th
      • Actually, a Jan '09 option with a strike price of $600 was worth $57.50 at the close today, but it did fall $11 today. See

        http://finance.yahoo.com/q/op?s=GOOG&m=2009-01 [yahoo.com]
    • Re:Or, you know... (Score:4, Insightful)

      by flagg9483 (940242) on Wednesday December 13, 2006 @10:50AM (#17222682)
      "...maybe they could just pay them more." But then you're missing the whole point on incentive based compensation. Giving stock options provides an incentive to work harder and improve the performance of the company. If you've ever been a manager you'd know that giving the same old raise every year does little to motivate employees, but when workers see a direct correlation between their effort and organization performance they can become great employees and have higher job satisfaction.
      • You obviously have never heard of Enron, you know that company that lavished share options on its management and employees to the point where maintaining the share price of the company at the expense of all other activities became the overriding goal of the organisation (it did not turn well for anyone in case you didn't know).
        • Re:Or, you know... (Score:5, Informative)

          by flagg9483 (940242) on Wednesday December 13, 2006 @11:45AM (#17223462)
          You obviously didn't read the article. The whole point of the Google plan is that it provides employees an opportunity to cash in the value of option and opt out of the equity investment should they so desire. It also still gives them the chance to hold company stock if they want to take the investment risk which is what Google would like. As a Chartered Accountant and auditor I'm quite familiar with Enron and the impact its had on my industry. In the Enron collapse there were two main problem caused by stock options. First, at Enron, executives who had significant share holdings were motivated to increase their own personal wealth at the expense of shareholders and employees. As the article states, this is for employees and not executives, so it shouldn't interfere with management's stewardship function. Second, employees lost money because they didnt properly diversify their portfolio's and because the proper regulations weren't in place to allow and insure investment risks were mitigated. The Google plan mitigates the risk of employees holding too much of the company's stock by providing them a quick cash alternative. It looks very much like Google is sacrificing some of the benefit of traditional incentive based compensation by giving employees an escape route. Employees win.
          • by aminorex (141494)
            Please explain to me how executives holding shares can increase the value of their own shares while acting against the interests of other shareholders.
            • by flagg9483 (940242)
              They can do so because of the information asymmetry between management and other shareholders. In Enron's case the management was hiding debt in special purpose entities. This artificially increased the share price above what it should have been. The market didn't know this, but Enron executives did, so they were able to sell early before the stock price crashed completely. They were also receiving some non-stock based compensation. In effect, because the stock price and earnings were high (artificiall
      • by archen (447353)
        I'd think it could also backfire and be demoralizing. Lets say I work for Microsoft as an example and they give me stock options. I bust my ass to try to make the company advance, but the endless amounts of red tape and BS is obviously choking the company and there's nothing I can do about it. Instead of at least getting a raise, I have a bunch of stock that is going no where and there's nothing I can do about it.

        Stock options worked great for the MS of old, but not so great as the current MS. Basically
      • Yes, but the correlation between individual effort and organization performance also decreases with the size of the organization.
        • Re: (Score:1, Offtopic)

          by somersault (912633)
          Ooh, a palindrome ID :o
        • by tehcyder (746570)
          Yes, but the correlation between individual effort and organization performance also decreases with the size of the organization.
          You mean that the correlation decreases as the size increases I assume.
  • by Timesprout (579035) on Wednesday December 13, 2006 @10:29AM (#17222454)
    Well everything Google does is innovative round here i guess. I thought the main reason stock options were out of favour was too many people took them in lieu of full salaries back in the boom days and ended up with nada after working their testicles off.
    • Re: (Score:2, Interesting)

      by bmac83 (869058)

      No, stock options are out of favor because they have previously provided an excellent way to compensate employees without such a huge negative impact on the income statement. As public scrutiny and regulations tighten, the bad behaviors of various companies are coming to light.

      This really is a big deal. Normally, your employee stock options are tied to you and cannot be sold. Since you have less "options," the value of these to employees is quite a bit less than normal stock options to normal investors

    • by afabbro (33948)
      The reason stock options are out of favor is that companies have to expense them now...
  • Nobody is punished (Score:2, Insightful)

    by nuggz (69912)
    sheesh
    the last year, employees and employers have been 'punished' by the IRS with new rules requiring options to show up as an expense on the bottom line.

    Stock options are an expense and should be accounted for.
    Google is trading at $480/share today. If Google issues 1 new share, the value of that share is $480. If this new share is traded for $480 there is no loss of value.
    If Google gives away this share for less than $480 they are basically losing that extra money. Forcing a company to record this lost mo
    • by nelsonal (549144)
      The trick is the company has to expense them at let's say $x, but the employee views them as having value of 0.05*x or so, and they make far less effective payment currency. Google's move is aimed at narrowing that gap.
    • As for options vs stock the valuation is slightly more complicated, but still well documented and understood.

      "Stuck on a desert island? Assume a survival kit!"

      The options vs stock is the very heart of the matter, and it is most certainly not well-documented and understood. The difficulty is that, even though the option, if sold on the market, had positive value, but the stock may fall in price, meaning the option is never redeemed for cash. So, it's an expense ... you never paid. Now, I agree that neverth
      • by nelsonal (549144)
        I don't know of too many financial experts (who are really disinterested) who can make a credible claim that binomial option modeling is massively incorrect on the value of the options granted. I wish companies would have granted tradable options which would have made the whole problem disappear (just use the market price for them). I agree though that the accounting for DB pensions is a much larger issue. I find it more than a little ironic that some of the biggest losers in the overcompensation of empl
        • I don't know of too many financial experts (who are really disinterested) who can make a credible claim that binomial option modeling is massively incorrect on the value of the options granted

          I wasn't saying that there's dispute on the market value of the options, but rather, whether the option's value should be put as an expense on the balance sheet before it's ever realized (and given that it might never be realized). There are reasonable people who don't think it should be.
          • by nelsonal (549144)
            I agree, but would rather see the argument shift toward moving balance sheets to better reflect the current exposure of all implied derivatives (like the pension example too) rather than continuing to ignore them catagorically.
            • I agree with you there. And that all levels of government should explicitly represent future entitlement obligation. My point was just that the issue is more complicated than the GGG(G?)P was making it out to be.
          • by nuggz (69912)
            Options do have a current value.
            If I get a paycheck in $, options, use of a company car or gold bars it doesn't matter.
            I should claim all as income, and the company should account for them as a salary expense, the form shouldn't matter.
            • Re: (Score:3, Interesting)

              by larkost (79011)
              I agree with you in general principal, but options but a lot of head scratching into what the value is. Here is the basic problem:

              When a company grants someone an option, they are giving that person the right to purchase a set amount of stock (from the stock that the company still owns) at a set price (usually tied to the the price of the stock at the close of the market on the day that the option is granted). There are usually then rules associated with the option about when they can exercise the option (u
              • by nelsonal (549144)
                The IRS waits until the options are exercised and considers the expense to be the difference between exercise price and market. However, options are essentially they way we value the chance that the stock will go up or down (and as such they have value above and beyond their exercisable value) and that value should be expensed (as the company gave it to you in exchange for your performance. Essentially there are relationships based on how volatile a stock is expected to be that have a huge impact on the o
      • by tehcyder (746570)
        I mean, defined benefit plans are ridiculous in the first place
        Says who? I'd say that a pension scheme without defined benefits is pretty ridiculous from the point of view of the potential pensioner. What's the point in saving x% of your income each year and ending up with less than if you'd just stuck the cash in a savings account?
        • LOL, small misunderstanding. I wasn't saying that "companies should offer pensions but not tell you what the value is". I mean, the whole idea of a company promising a fixed annuity based on pay an years of service is stupid. They can never know how much to fund, so they're either

          a) eventually underfunded
          b) rely on new suckers, I mean employees to join them, making them effectively a Ponzi scheme
          c) not under your control, so someone can raid it and leave you with no recourse (because they can't pay damag
  • Black-Scholes (Score:3, Informative)

    by BrotherZeoff (776525) on Wednesday December 13, 2006 @10:59AM (#17222794)
    http://en.wikipedia.org/wiki/Black-Scholes [wikipedia.org]

    This is the main theoretical method for option valuation.

    The formula was derived by Fischer Black and Myron Scholes and published in 1973. They built on earlier research by Edward O. Thorp, Paul Samuelson, and Robert C. Merton. The fundamental insight of Black and Scholes is that the option is implicitly priced if the stock is traded. Merton and Scholes received the 1997 Nobel Prize in Economics for this and related work; Black was ineligible, having died in 1995.

    I think it's really cool what Google is doing here - get some actual values which can then be compared to the Black-Scholes values. Doesn't it seem possible that Google will be willing to auction off other firms' options as well, if this catches on?

    • by flagg9483 (940242)
      Black-Scholes will be a little complex for most employees, and perhaps even for Google's techies, although interesting from a theoretical point of view. The price available to employees will likely a simple value close to the options intrinsic value (stock price minus exercise price), plus or minus a premium determined by the bank for time value or discount for transaction costs.
    • by ibbieta (31756)
      The formula was derived by Fischer Black and Myron Scholes and published in 1973. They built on earlier research by Edward O. Thorp, Paul Samuelson, and Robert C. Merton.

      What is interesting, to me at least, is the people mentioned as providing "earlier work". Edward Thorp is probably more popularly known as the guy who wrote the first real Blackjack strategy book, "Beat the Dealer". After a short stint proving the validity of card counting strategies for Blackjack in real casinos, he went on to apply much
    • Actually, now that you mention it, I should add that my company matches 401k contributions, but requires you to buy company stock with the match (though not with your own contribution). You then have to hold it for ~2 years. I didn't like that. So for a while, I was seriously considering ways I could monetaize that holding so I could diversify it. One way would be to sell the shares now, with a time lag of the required holding period. Another way would be to sell the option to buy at some price at the e
    • Yeah, what they need is to establish some kind of 'market' where dealers establish the price of options based on the aggregate demand. Oh, wait... [cboe.org]
  • by Xemu (50595) on Wednesday December 13, 2006 @11:01AM (#17222824) Homepage
    The search giant will let employees sell their vested stock options to selected financial institutions in an auction marketplace

    That's pure genius! Perhaps we could have professionals bidding on this market place and call them "auction brokers" and we can then have all these professionals work in a place we call the "auction exchange". We could then allow any company that meets certain standards to hold auctions on this market place and code different company auctions with a letter code we can call "auction ticker".
    Imagine the possibilities.
    • by mre5565 (305546) on Wednesday December 13, 2006 @12:36PM (#17224270)

      You and people who modded you up are laughing because you fail to understand.

      There are basically two types of options: stock option grants to employees, and derivatve options sold by options exchanges. The latter come in the form of puts and calls. A person who buys a put option is buying the right to sell 100 shares of a specified company to seller of the put at a specific price. A person who buys a call option is buying the right to buy 100 shares of a company from the option seller at a specific price. One buys a put option if he expects the price of the stock to drop. One buys a call option if he expects the price of the stock to rise. One who buys a call or put can sell it later if he wants. The call or put usually has a short life time (a few months usually), and expires if not "exercised" (i.e. the owner of the call buys the stock, and the owner of the put sells the stock).

      Employee stock options are basically call options that the company has sold to the employees for zero dollars (well technically the company has bartered the options to the employee in exchange for their labor). However, employees cannot sell these options on an open market. All they can do is "exercise" (i.e. "call the option" by buying the stock from their employer). At least, not until Google.

      Why would an employee want to do this? Because sometimes call option prices have built into them a future expectation of price appreciation. It is possible for the employee's call option to be sold for more than the current market value of company's stock. And with GOOG's rise over since its IPO, many buyers of GOOG call options would be willing to make that bet. An employee can thus bank GOOG's future appreciation now, and diversify now (or he can use the proceeds to buy more GOOG). Another example would be employees that have "under water" options; options that have a strike price higher than the current market value of the GOOG. Without Google's new options market for employee, such options are worthless. Whereas, with an options market, such options might be worth something, even it is just a few dollars per option. There are lots of employees of former high flyers like Sun that would be interested in such a market, because they hold options with strikes of $50 per share or more.

      So this is a good, employee friendly, thing. Yes it is an obvious idea, but keep in mind that the investment industry is very conservative, and it sometimes requires people like the Google founders to question conventional approaches.

      • by vidarh (309115)
        Why would an employee want to do this? Because sometimes call option prices have built into them a future expectation of price appreciation. It is possible for the employee's call option to be sold for more than the current market value of company's stock.

        That doesn't make any sense. If the cost of the option is above market price, then it would be cheaper for a purchaser to just buy the stock itself on the open market and hold it. The market value of a call option will always be lower than the market val

      • by havockla (751402)
        Good luck to everyone at Google at getting a fair price on your options. Seems to me it would be smarter to let them sell the options ON an exchange where there is a competitive bidding process. Then again...i am sure there is some reason I am not aware of that it can't be done. Still...good luck, I am sure that you will have the most competitive market that is available. I am sure JP has your best interest's in mind :)
      • Re: (Score:3, Interesting)

        by aminorex (141494)
        Its also good for Google, because they can bid on the options themselves, which means they reduce the size of the float, and do so by booking treasury shares at par (usually 0.01$ or 1.00$) instead of booking them at market prices. It's also good for Google shareholders if Google is reducing the size of the float. Frankly, I think it's not brilliant but a good, sound idea, a win-win-win idea. (Assuming the employees make good decisions.)

      • I read about 50 comments and your's is the most informed. However you still have a lot to learn about options. The Google plan in my opinion is creative but not well thought out. Any employee or executive can presently hedge his options with exchange traded calls quite easily. Proper hedging will increase his return, reduce taxes and risk with the Employee getting about 50% more after tax compared to some elementary strategies promoted for mass consumption. The Google plan will merely end up by putting
    • by LauraW (662560)

      That's pure genius! Perhaps we could have professionals bidding on this market place and call them "auction brokers" and we can then have all these professionals work in a place we call the "auction exchange".

      I'm sorry, but I've patented that business method. Want to license it?

      (Sorry, I couldn't resist.)

  • by danpsmith (922127) on Wednesday December 13, 2006 @11:25AM (#17223134)
    Google's move could once more significantly change compensation for employees in many industries, including tech.

    Nice try Google, I mean you can try to change compensation for tech employees but in the end, as the saying goes: The bubble-era vision of a Utopian Internet is dented and dirty... The Lexus has collided with the olive tree, and its crumpled hulk spins in a ditch as the orchard smolders.

    • by Webs 101 (798265)
      Oh, I wish I hadn't used up my mod points last night. That comment deserves +17 for funny and for recursive.
  • Isn't this this same thing what McDonald's does for their employees? Same with Walmart?
  • Giving them the option to sell the stock publicly is alright. However, it is still an unsecure benefit. Companies today are giving their employees more riskier benefits. Its like giving lottery tickets as a christmas gift. This stock option is similar to that. What if now Googles stock starts to drop and stays well below the price it is now? Then the employees have lost a lot of money in that investment and end up selling at a low price to institutions like Morgan Stanley, etc. Who can then turn around and

    • Where have ethics gone? Corporate America used to have it but it lost it somewhere in mid 90s.

      They lost it a lot earlier [wikipedia.org] thanks to Reagan. It's a lot easier to go to the bargaining table when you just gave corporations a signal that they could smite workers at will without a care in the world.
  • This has nothing to do with tax avoidance. Microsoft's plan had more to do with underwater options but it was basically the same thing. An option that is underwater has no current value but does have value in the marketplace. Microsoft allowed employees to sell their underwater options for their market value. The difference was MS's plan was limited to underwater options and was a one-time all-or-nothing deal.
  • I must clearly be missing something, but I just don't understand how this is useful. As a stock option owner myself, I am not required to keep the shares I buy when exercising options. Our stock option plan administrator allows immediate turn-around and sell, using the proceeds to finance the purchase of the discounted stock. I would think every plan allows this. Maybe that's what I am wrong about...

    1) Share price > option price : Why would anyone pay more for an option than the difference in actual and
    • by nelsonal (549144)
      If you truly believe that then I will take any underwater options you wish to give away (I might even surprise you with the price I'd be willing to pay).
    • I must clearly be missing something, but I just don't understand how this is useful. As a stock option owner myself, I am not required to keep the shares I buy when exercising options.

      It is useful because the market value of an option is always greater than its "par value" that you would get from a cashless exercise (i.e., market price minus strike price). From what I understand regular exercises (including cashless ones) will still be permitted.

      The key here is that options are a leveraged instrument

  • PBS Frontline's 2002 documentary Bigger than Enron [pbs.org] (watch online here [pbs.org]) gives a good summary of how Enron and other big companies and accounting firms use stock options to fuddle-duddle their performance, and how they pay off Congress to keep it that way.

    PBS has a number of other +5 Insightful documentaries that you can watch for free online [pbs.org], including other financial-related ones on Complicated tax shelter schemes [pbs.org] (2004), credit card company tactics [pbs.org] (2004), and The end of pensions by 401(k) [pbs.org] (2006).

    I stron
  • I wish my company would copy Google's example.

    I had always assumed, because no company had ever done it before, that it was illegal to make employee stock options tradable.

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