Just before the turning of the New Year, the New York Times printed an article about the potential for large cash windfalls to CEOs who received mega-sized stock option grants during the lowest points of the stock market downturn in 2008 and 2009. Judging from the number of Google Alerts that subsequently came to my inbox on this topic, it seems the article stirred some strong opinions, particularly about the corresponding potential corporate tax deductions.

High Value Non Qualified Stock Option Exercise = Hefty Corporate Tax Deduction

In summary, during the lowest points of stock market performance, many companies issued larger-than-usual stock option grants to their executives. Now, with the market on the rebound, and barring a relapse, many of these grants are well in-the-money and primed to generate huge windfalls of cash for the executives upon exercise. Hand in hand with large cash gains for the executive would be a hefty tax deduction for the company. Estimates run in the billions in terms of shares granted and potential dollars in gains resulting from the grants in question. According to the article, “of the billions of shares worth of options issued after the crisis, only about 11 million have thus far been exercised, according to data compiled by InsiderScore, a consulting firm that compiles regulatory filings on insider stock sales.” This seems to indicate that most of the potential windfall is still on paper, and there may be many significant stock option exercises to come.

What’s the Buzz?

Critics of the stock option tax deduction provisions within the Internal Revenue Code are already vocalizing dissent over the possibility that many companies may drastically reduce, or altogether eliminate, their tax liability due to the large sized deductions that would accompany such significant executive gains. Barbara blogged about a similar concept back in September. As I thought about this possibility, it occurred to me that this is not the only time in history that large windfalls equaled large deductions. In fact, anytime there is an uptick in a company’s stock and a stock option appreciates, there is value. This could be in parallel with market conditions, or simply because a company is performing well, or both. When that value is recognized in the form of an exercise of a non-qualified stock option, the company receives a corresponding tax deduction. Since executives are usually the employees with the largest stock grants, it’s likely that the largest corporate tax deductions typically originate from executive transactions. This isn’t a new trend.

Déjà Vu

I’m thinking back to the 1990s up through 2000 when the stock market was bullish, and feeling like I’ve been here before. Which prompts me to say “so what?” Now, before I get dozens of emails correcting me on statement, the “what” that is different in this situation is that it seems many of the stock options granted in 2008 and 2009 were particularly oversized, seemingly because of the state of the economy and miserable market conditions. In addition, many of those grants were free of performance conditions, which means that the potential windfall in many cases may be a pure reflection of a market rebound, and has nothing to do with the executive or company’s performance. That thought has stirred some buzz, and it seems likely to continue as more paper gains translate into real cash through exercises. It seems that time is upon us, or not too far into the future. This will be a topic that is bound to generate some buzz in the coming months. I wonder if Senator Levin will use this as yet another opportunity to try and get his bill (limiting stock option tax deductions to the expense recognized for them) through Congress. It seems like 2012 may be a year of epic stock option gains; we’ll just have to wait and see.

-Jennifer