Terry Adamson of Radford gets 10 points for answering my “think fast” challenge on two times when the Black-Scholes value is not significantly higher than intrinsic value (“Realizable Pay,” April 2, 2013). Terry’s answers:
When there is a significant dividend yield, then Black-Scholes will be less than intrinsic value.
When an option is well “in-the-money”, then Black-Scholes would be very close to the intrinsic value (i.e., the time value shrinks to nothing with options that are well in the money).
Also, when an options is close to expiring it has very little time value, so the Black-Scholes value would not be much higher than intrinsic value. Hmmm, I think this might show up in the Question of the Week Challenge soon.
Survey Deadline Extended
We’ve extended the deadline to participate in the NASPP’s 2013 Domestic Stock Plan Design Survey (co-sponsored by Deloitte). Don’t dilly dally; we can’t extend the deadline again.
This week, we feature another installment in our series of guest blog entries by NASPP Conference speakers. Today’s entry is written by Bill Dillhoefer of Net Worth Strategies, who will lead the session “Supercharging Your Stock Option Grants.” 10 pts to Bill for successfully using the word “quants” in his entry!
My company has been providing equity compensation decision support services since 1999 so we have witnessed firsthand a great deal of the development in stock plan participant education. Here’s a brief summary…. The internet bubble (1995 – 2000) instigated many companies to begin offering broad-based employee stock option programs. These companies had to provide participants with basic information about their stock option grants because options were new and mysterious. This was the “Options 101” phase because these communication programs generally avoided the more complex aspects of stock options.
This early phase of participant education may have transitioned into one that addressed advanced topics had it not been for two major factors. First, the internet bubble burst, causing the appeal of stock options to decline because underwater grants were perceived as worthless. Second was the adoption of FAS 123(R), which eventually resulted in the curtailment of broad-based option programs and the increase in popularity of restricted stock/units. Consequently, the adoption of advanced stock option education programs never gained popularity among issuing companies.
Nevertheless, stock options are still a widely used means of granting equity to valued employees. Even if your company isn’t currently granting new stock options, if your employees have outstanding options grants you can significantly increase their perceived value. It is often said that “perception is reality” so by simply educating participants on the Black Scholes value of their grants, this value become a reality. Now you are probably thinking this is crazy because Black Scholes is WAY over their heads and will only serve to confuse and discourage people. On the contrary, learn the secrets and benefits of providing employees with Black Scholes based information by attending “Supercharging Your Stock Option Grants” at the 20th Annual NASPP Conference.
This presentation consists of four sections. Professor Anne Farrell will present academic research showing that individuals misunderstand the full value of their employee stock options and how basic training can significantly change their subjective valuations. Next, I will introduce two time value based metrics: Forfeit Value and the Insight Ratio. These metrics can be incorporated into stock option communication programs and can increase retention and motivation by helping employees make informed decisions. In the third section, Clinton Shoap from Cargill, Inc. will provide examples of how they have successfully used time value information with their employees. Finally, Larry Bohrer from Charles Schwab will describe their approach to helping companies to realize the full potential of their option awards and how complicated concepts can be understood by participants when presented in the right framework.
Who says Black Scholes is only for quants? Delivered in the right manner Black Scholes information can be fun and profitable for employees with stock options. “Supercharging Your Stock Option Grants” should not be missed.
I’m sure many of you are familiar with the limitations of the Black-Scholes model when it comes to valuing stock options for accounting purposes. Today I write about the problems of using the Black-Scholes model to determine grant sizes.
How Much Did Your CEO Make Off the Financial Crisis? A recent article in the Wall Street Journal (“Options Given During Crisis Spell Large Gains for CEOs” by Scott Thurm, April 26) discusses windfalls CEOs have seen in their stock options that were granted during the financial crisis. Many companies granted options to their CEOs when their stock price was at a low point. Because options are virtually always granted with a price equal to FMV (only 1% of respondents to the NASPP’s 2010 Stock Plan Design Survey, co-sponsored by Deloitte, granted premium-priced options), this results in a low exercise price.
Further compounding the problem is the method most companies use to determine how many shares to grant. 70% of respondents to the NASPP survey determine grant sizes based on, at least in part, the value of the grant. And for 85% of those respondents, for stock options, that value is determined using an option pricing model, such as the Black-Scholes model. What happens to the option value computed under one of these models when the stock price is low? The option value will be low as well. The end result is a larger grant, assuming companies are trying to grant a specified value. In addition to having a nice low exercise price, options granted during the financial crisis were for many more shares that would normally have been granted.
The upshot is that when the stock price recovers, the options are worth a lot of money. A lot more money than options granted during times of economic abundance, which seems counter-intuitive. Generally, options with low exercise prices are coveted by employees and executives; it hardly seems necessary to make these options larger than comparatively higher-priced grants.
What Can You Do About It
Well, at this point, there may not be much that you can do about options that have already been granted–although see my May 13 blog (“Eleven and Counting“) about GE and Lockheed Martin modifying options granted to their respective CEOs to vest based on performance. But you may be able to adjust your grant guidelines to address this sort of problem in the future. Here are some practices to consider:
Base grant guidelines on a set number of shares, rather than grant value. This number might be determined by the run rate or overhang the company desires to maintain.
Set a cap on the number of shares that can be granted to any one person, regardless of award value.
Base grant value on an average, rather than a spot value.
Cap the amount of gain that can be realized from option grants. Not only does this help address this problem but it can also reduce plan expense.
Grant premium-priced options, particularly when the FMV is unusually low.
Base grant sizes on projections of future gain for various possible growth scenarios.
Impose performance conditions on options granted to executives–this at least ensures that executives are performing, rather than merely benefiting from the general market recovery.
Be sure to tune into the NASPP’s upcoming webcast, “Equity Values of a Different Flavor,” which will discuss some of the problems with using option pricing models for compensation planning purposes and possible solutions.
Another Chance to Qualify for Survey Results Due to overwhelming demand, we have extended the deadline to participate in NASPP’s 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte) to June 10. Issuers must complete the survey to qualify to receive the full survey results. Register to complete the survey today–there won’t be any more extensions!
New “Early-Bird” Rate for the NASPP Conference If you missed the first early-bird deadline for the 19th Annual NASPP Conference, you can still save $200 on the Conference if you register by June 24. This deadline will not be extended–register for the Conference today, so you don’t miss out.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
Register for 19th Annual NASPP Conference (November 1-4 in San Francisco). Don’t wait; the new early-bird rate is only available until June 24.
Participate in the NASPP’s 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte, with survey systems support provided by the CEP Institute). You must complete the survey by June 10 to qualify to receive the survey results.