During the past few years, many corporations stopped offering the employees stock options as special incentives belonging to the benefit packages. Even though a few companies stopped offering the options for the express purpose of saving money, the primary reasons involved a few prevailing issues that persuaded managers to reduce these types of benefits:
- If the stock’s value experiences a significant drop, employees will not have the ability to sell their options. However, the company owner or bookkeeper must report all involved expenses while shareholders risk what is known as “option overhang.” When option overhang exists, buying the options at specific prices become problematic.
- Numerous employees are uncomfortable with this type of compensation designed to reward them for their efforts at performing their tasks. Today’s employees are aware that the economy often dictates various stock market events including causing options to lose their intrinsic values. When options become worthless, employee benefits are similar to the free play promotions offered by casinos as opposed to players receiving real money.
- Accountants do not typically enjoy keeping track of options. Trading in derivatives typically means that the costs may outweigh any potential gains. Higher paid staff members would rather receive improved salaries in lieu of options. If employers eliminate options from employee benefits, they can then afford to give wage increases.
Advantages of Offering Stock Options
In spite of the difficulties, some employees may still prefer to receive stock options over extra wages or even improved benefits. For these employees, low-cost insurance coverage for their families offers an attractive incentive. The reason that some higher paid executives prefer stock options is related to the fact that they readily comprehend how stock option benefits work. Plus, a stock option benefit means that each employee receives a similar type of compensation.
Moreover, personal earnings are increased only when the values of the company’s shares are elevated. When employees understand that their options depend on the performance of the company, they are more likely to work harder to ensure that the corporation attains an ultimate degree of success. In addition, employees may demonstrate obvious improvements in their zeal to serve customers with excellent service. Another attractive reason is that creativity becomes more prevalent when staff members want to make sure that their options increase in value.
When contemplating the concept of granting stock equities to employees instead of options, many employers are hesitant because of Internal Revenue Service (IRS) regulations. Executive employees who are at the top rung of the ladder may receive complex compensation packages that do not meet with complete IRS approval ratings. For instance, a chief operating officer (CEO) who prefers doling out equity shares over options may need to pay more taxes. Consequently, stock equities do not provide a cost-effective way to compensate valuable employees.
Solution to the Problem
Employers need to find a good strategy if they want to make stock options available to employees. The proper method equals the avoidance of strenuous expenses while also minimizing overhang. According to Jeremy Goldstein, an accomplished lawyer, one of the best solutions is to implement “knockout” barrier options. Knockout options are similar to stock equities in that they experience similar vesting requirements and time limits for making purchases. Still, employees with knockout options risk losing their benefits when the share values dip lower than certain designated amounts.
For instance, an employee may have an option with a five-year term. The employee can purchase a stock for $150 per unit. If the value of each share dips lower than $75, the option simply expires. Consequently, the employer can cancel the options if the share value does not regain its composure. Furthermore, the knockout option helps to lessen costs in the accounting department.
When the option is only valid for a few hours or days, the accountant does not need to spend as much time working on calculations. In addition, the option of offering knockout options to staff members means that the firm’s annual earnings report is typically more accurate. Plus, shareholders view the options as attractive and desirable benefits.
Important Things to Consider
While it is true that knockout options do not provide the answers to every employee’s prayers about improved benefits, they do eliminate some of the problems typically associated with stock equities. Even so, entrepreneurs offering knockout options need to work with experienced auditors who are aware of the possible inherent dangers for staff members.
For example, a business owner considering the possibility of offering knockout options to employees may want to wait at least one year after the current derivatives expire before offering new replacement options. If the entrepreneur refuses to wait for an adequate period, the new options may cause the company’s quarterly statement to look negative.
A Few Words about Attorney Jeremy Goldstein
Jeremy Goldstein has had more than 15 years of experience as an attorney specializing in business matters. Corporation CEOs looking for valuable legal advice about the best ways to offer benefits to employees typically seek Jeremy Goldstein’s assistance. After working as a business partner with another lawyer, Jeremy Goldstein co-founded Jeremy L. Goldstein & Associates, LLC, a boutique law firm located in New York City, New York. The prestigious legal firm specializes in advising CEOs, compensation committees and corporate management teams about the best ways to compensate top executives.
Jeremy Goldstein has been involved in significant financial transactions concerning several companies including AT&T, Bank One, Chevron, Merck, Goldman Sachs, Bank of America Corporation and Verizon. In addition, Jeremy Goldstein serves on the board of directors of the Professional Advisory Board of the NYU Journal of Law and Business, an established law journal, and of Fountain House, a charitable organization dedicated to helping people recover from mental illness.
Check out his website