Tax Break for Stock Options Attacked in NY Times Article: Do You Agree?

I think I have read this article (in various forms four or five times during my career.  It chose its conclusion then found facts to match.  There is not mention of the companies who suffer with the expense of underwater options.  There is no mention of the risk offered by options at most companies.  There is no mention that just a few years ago it was common opinion that we were on the verge of a depression and that the stock market might not recover for years.

Every time stock options leap in value a story like this follows.  No one was complaining too loudly when these options were granted.

There is some truth to the story.  Some companies took advantage of the depressed market to opportunistically grant options at unusually low prices.  Most companies struggled with grant equity during that down time.  The values they were granting prior to the crash could not be sustained given burn rates and shareholder-approved plan pools. 

This was prior to Say-On-Pay and before the big move to performance-based equity.  We will see a continued rise in the use of Performance Units (not options) over the next year or two.  Then we will probably see a drop and a return to options (we tend to run in 3 yr cycles.)

Look, I wish I made those gains too. I wish that my company was able to utilize a tool like this to compete on the world stage.  I do not currently wish that my firm was subject to the whims and control of a publicly traded market that often ignores individual corporate success or failure in the name of "market movements."  There are ups and downs with all rules.  Few seem to remember to that companies were struggling to pay their employees when cash was short and outstanding underwater equity was long.  Most seem to think that the majority of companies did option exchanges or repricings, when in fact only a small percentage followed that path.

Of the "billions of dollars" of equity granted only 11 Million has been exercised so far.  Given past patterns a large percentage will remain unexercised and eventually expire out of the money. 

Several years ago a group of industry people and I met with the Treasury Department to discuss their plan to require the withholding of FICA/FUTA and Medicare at the time of exercise of ISOs and at the time of purchase of ESPP.  They claimed that it would raise $23 BIL over 10 years.  When I asked how they cam up with that number that explained tht they had used the values from 1998-1999 (the highest years of exercised/purchased value ever to that point), just prior to the dotcom crash. When I pointed our that most of the companies they used as a sample no longer even existed, they admitted that they may have over-estimated their gain.

There is not exact math or formula.  We will see more controlled use of all equity vehicles as Say-On-Pay evolves (look to the following story about Say On Pay outside the US.)  This will change how stock options are used.  The market will also become more traditionally predictable.  This will flatten values as well.

Carl Levin has been riding this horse for a while. I don't think that this will have staying power as examples of more thoughtful executive compensation starting become more common.

Bruce:

You ask: "Do you know of any data on how much tax revenue it generates?

The Papers linked below by Ilona Babenko may answer that question.

http://www.slideshare.net/OLAslideshare/ssrn-id1101271

http://www.slideshare.net/OLAslideshare/employee-stock-options-and-investments

John Olagues

P.S. It can not be denied that companies do like the cash flow that comes from the exercise. And the earlier the better. The cash flow comes earlier when Restricted Stock vests... they do not have to wait for the exercise.

This whole argument is really misguided. What is a deduction to the company is ordinary income to the employee, and the personal tax rates are generally significantly higher than the company rates. So these NQ option exercises (or restricted stock vests) are a net revenue gain to the Treasury.

Peter

http://www.palisadeshudson.com/2012/01/new-york-times-tilts-news-on-taxes-again/

This blog response is well written.