Google Offers Innovative Stock Option Scheme

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.

Black-Scholes

[BrotherZeoff]

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?

Re:Sorry, I call BS

[Joe Decker]

I'm not sure I understand your dismissal. It sounds to me like Google is not trying to avoid expensing options. It sounds to me like Google is using the method they're proposing, much as Coca-Cola already does, do determine a fair market price for the options, a step which makes the determination of the value of the expense to be included on their books a lot more direct. So, where's your beef?

Re:Or, you know...

[flagg9483]

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.

Re:WOw, what a neat idea

[mre5565]

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.