Options on Google employee options?

Google has announced a Transferable Stock Options plan for Google employee stock options. The plan allows employees to sell their vested stock options to the highest bidder, a process managed by Morgan Stanley.

In the tech world it is very common for employees to have stock options. There have always been two ways to handle vested options. You could exercise the options when they vest, sell the stock, and pocket the difference between the option strike price and the current market price. Or, you could continue to hold the option after it vests, sometimes up to 5 years, hoping for a higher price, and delaying the capital gains impact.

This new Google TSO program allows employees to squeeze a little extra value out of their employee stock options. There is still "time premium" left in the vested stock option because the options typically do not expire for several years after they vest. Institutional investors are willing to pay money for that "time premium" left in the option.

Google provided its employees with an example of how this might work. I will paraphrase it here. Tom and Sally each have vested options for 100 shares at a strike price of $400. Assume the current market price is $500. Tom takes the traditional path by exercising his $400 options and selling the stock for $500, making $10,000, less capital gains taxes. Sally is smarter than Tom...she checks the employee web site to see what other financial institutions are willing to pay for her 100 options. An institution is willing to pay $150 for her 100 options, netting her $15,000, before taxes.

UPDATE: The real value in this program is for "under water" options. Employees who joined Google last month when the stock was $513 per share are now $35 per share under water and thinking maybe this wasn't such a smart move. Think again. Some of your options will vest in November 2007 and expire in November 2009. The value of that "under-water" option today is somewhat over $90. For more detail on why "under water" options are worth a lot of money see my other post here.

This is a win/win/win for employees, Google, and the brokerage houses. The employee optimizes the value of their options. Google avoids an avalanche of employee vested stock options hitting the market all at once. The brokerage houses get a little better deal on Google options than on the open market.

There are pundits who see evil and perhaps a hidden agenda in anything an industry leader tries to do. As anyone from Microsoft will tell you...it goes with the territory. Sorry guys, but I don't see any evil here...just creative and innovative thinking, putting employees interests first.

Microsoft is a great company to work for...always putting employees first. Microsoft has the best health insurance program in the world. Employees pay nothing...no employee contribution, no co-pays, no deductibles. It is awesome.

Microsoft also gives employees stock grants every year. Stock grants are outright grants of stock with no "strike price", just a vesting period. For example, an employee might receive a  1,000 share stock grant every year that vests over 5 years. At the end of the first year the employee vests 20% or and is given 200 shares free...no strike price to pay. The employee also gets another stock grant, based on performance, that vests over 5 years. At the end of the second year the employee gets two stock grants, 200 from the first year and another 200 from the second year, plus a new stock grant, again based on performance. Needless to say, by the end of the 5th year the Microsoft employee is doing very well.

Employee compensation is very competitive in this market. Microsoft and Google are constantly raising the bar. Competition always brings out the best, generating lots of good choices.

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Comments

[Paul Kedrosky]

Hey Don --

Contrary to your post above, I didn't suggest Google has a hidden agenda. Matter of fact, I think it is creative thinking by Google.

My interest, for the most part, had to with signals to capital markets, privileged access to information, and so on. Where, for example, do I get to see bids, offers, and volume on this institutionally-run internal option exchange? I want that data, and do not want it be Morgan Stanley only that gets to watch the orders fly by.

P.

[Don Dodge]

Paul, I understand your issue on transparency, but it was probably far worse in the past.

My experience is as an employee and stock owner of several start-ups that went pulic. The way it worked then was that employees and insiders were encouraged to sell their stock ONLY through the original underwriter, say for example, Morgan Stanley.

Most employees opened accounts with the original underwriter and sold all their stock through them. The underwriter was in a position to "manage" the flow of stock and maintain an "orderly" market.

In effect they could match buyers and sellers internal to the brokerage house, move big blocks of stock without causing a ripple on the overall market, and manage the timing of stock sales to avoid wide swings in the price.

All the major underwriters did this back in the day when IPOs were hot.

I agree that Google's TSO plan could possibly allow the big institutional brokerages to arbitrage certain stock movements, but the SEC and other regulatory agencies are watching this stuff like a hawk. No one wants to get caught in a "back dating options" trap or anything like it. So, I think the risk is small.

[Seth Finkelstein]

Don, the "evil" was a rhetorical question, in the sense of asking who was getting the best deal here. I acknowledge the general market argument. But I think analysis should go deeper into the ramifications of the move on Google's particular situation. Stock options are such a complex and contentious topic, and can have many destabilizing and unintended effects (e.g. who would have thought that receiving/exercising stock options would lead to the "tax trap"? Backdating scandals? Expense accounting controversies?). So I'd say the implications are worhy of exploration.

[John Olagues]

There are several issues with the program:

a) Will the option, once sold, still carry the possibility that the employee may terminate early and have the expiration date accelarated or will the options maintain the full term?

b) Doesn't the transferability reduce the mutual alignment of employee to employer? Would not that somewhat undermine the purpose of the options grant?

c) How much of an advantage will the employee get by selling and receiving the intrinsic value plus some "time premium" relative to what he can achieve by presently "writing" listed calls to hedge the options against ESOs and long stock?

d) Who will be able to trade the options with the employees?

e) The options are not now allowed to be used as collateral for hedging purposes now? Will the options once purchased be good collateral for hedging by the purchasers?

I think it offers some exciting posibilities for traders especially if the terms of the options become standardized.

To make this work, Google would have to do a good bit of work in designing the options to make them salable.

[Julie Brown]

You say:
> Some of your options will vest in November 2007
> and expire in November 2009.

Google options, like Microsoft options, expire in 10 years, so options that initially vest in Nov. 2007 (and fully vest in Nov. 2010) wouldn't expire until 2016.

As a side note, you didn't mention all that much about the reasoning behind the move. I forget whether it was Sergey or Larry who best summed it up: "the SEC says we have to account for these options as a business expense of $100 or more each. If I'm going to be charged $100 each, then I'm going to make sure they're actually worth that much to my employees!"