Looking at the Fine Print of Gooptions
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Written By Kew Kelly-Yuoh | December 14, 2006 | Share This
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Big news for Google employees - thanks to a new TSO program dubbed “Gooptions“, employees can now sell vested stock options to high bidding financial institutions. From the Google blog: “Employees will still have the choice of simply exercising and then holding or selling the stock too. But if they choose to sell the options, they can use a simple online tool that will show them the best price a participating financial institution is willing to pay for their vested options in real time.” Read this CNET post for a more detailed explanation.
Initially hailed as an innovative HR strategy, then called “good for investors“, the option plan has received so much praise that Internet Outsider asks, “If anyone has figured out the drawbacks of Google’s new transferable option plan, please weigh in, because at first glance it looks like a win all around.” Though numerous ‘draw backs‘ have been suggested, including “an employee rush for exits”, “shareholder dilution” and “arrogance”, I’m surprised that no one has pointed out the most important nugget from plan’s fine print:
The term of an employee’s option goes to the LESSER of 2 years or the remaining term of the option. If your option is in-the-money, then yes, under the new program you can now capture the intrinsic value plus time value, no brainer, it’s been written about exhaustively by the enslaved Google PR horde. If your option is underwater, however, it’s a different story - You’re left with only the time value, and the key question is, “How does that time value change when I’m selling a 9 year term option to an I-bank that is pricing it with a 2 year term (and trying to screw me every which way to Sunday)?”
Assume Google is trading at $480, strike is at $480, annualized volatility of about 35% and risk free rate around 4.5 - 4.7% (good thing the yield curve is pretty flat between 2 and 10 years). You run a Black-Scholes with these inputs for a 9 year term vs. a 2 year term option, and discover that the time value of the 9 yr term is about 2.2x the 2 yr term option. In fact, that ratio increases as the price falls further below strike. In other words, the more the strike price falls, the more employee gives up when he/she sells the option.
Employees should at the very least wait until their underwater option has a 2 year term left before selling it. This way they a) don’t take the time value hit, and b) maximize chances that intrinsic value increases above zero during the next 7 years (in our hypothetical example). Or, maybe the Google employee decides to cash out the 9 year term option, bank on getting a 200% return over the next seven years, break even on the time value side, and ignore intrinsic value.
But the real issue is - did any Google employees really follow what I just wrote? Can the bally-hooed employee base with their “withering intellect” make the leap to the finance world? Do any of them really care about the fine print?
I propose that the new plan is less an incentive for HR than it is a plug for PR. In that sense, maybe it is a “win” all around.
Topics: Google, Investment, M&A |