4 Details Rising Executives Should Know About Their Company Stock Options
As executives advance in their careers, they are presented with unique compensation options, including deferred compensation and in many cases, stock options within the company. Stock options are granted to the executive, allowing them to purchase company stock at a predetermined fixed price for a set amount of time. Many view stock options as a way to unite the financial interests of both executives and shareholders.
Stock options also offer plenty of upside potential if the correct strategies are employed. As an executive-level employee, you have clear insight into the company's management structure and the stock's future potential for growth. But company stock benefits can be complex, and like all forms of executive benefits, require special planning approaches. Executives are wise to align with a financial advisor who is familiar with navigating the executive benefit space.
To realize the true value of company stock options, executives should understand some of their more unique attributes, including:
1. Vesting schedules- When you are granted company stock options, your employer has the opportunity to set the vesting schedule on the options. The company has full control over the schedule, and terms can differ company-to-company, but typically the options cannot be exercised for this set time period. For example, a company may offer stock with a four-year vesting period, where 25 percent of the options vest in each year for the duration. It's essential to know what your company's policy is and when these options vest so you can best plan your exercise strategy.
2. Restricted stock vs. options- Some companies will issue restricted stock instead of options, or let executives choose between the two. Restricted stock is ownership shares that are issued to executives. These shares are non-transferable and must comply with specific SEC guidelines. Restricted stock is also guaranteed at a set price level, so it will always carry worth. However, because of this, companies will dole out fewer restricted shares. In contrast, options set a strike price once the contract is formed, affording executives a predetermined price at which the underlying security can be purchased or sold. Once restricted stock is vested, you have to make a decision whether to hold or sell the shares, and any capital gains will be determined by your holding period. To get the most out of restricted stock or options, it's important to understand these differences. If you can have both restricted stock and options, it is often preferable to have the options exposure to your company over the restricted stock because of the limited downside.
3. Tax implications- Company stock options are considered a form of income, so it is essential that they are considered for tax purposes. Income is realized when the options exercise, so it's important to implement the right tax strategy to avoid moving yourself into a higher tax bracket. For example, if you have an option set to expire in June 2018, but you have a low tax year for 2017, you can exercise the option early so the income is realized in your lower tax year. It's best to consult an advisor when designing the tax-focused strategy. If you wait until the options expire, you have no room to employ a more efficient strategy.
4. The intrinsic value- Investing in any company entails upside potential and downside risk, and your company's stock is no different. One aspect of company stock options that often gets overlooked is the value the option itself provides. A lot of executives worry the option will lose its worth if the stock drops, but in reality, options provide investors considerable leverage with limited downside risk, which has inherent value in itself. This can be measured by the Black Scholes Model, but your advisor can also help you calculate your options' value. When you exercise an option, you are also giving up this intrinsic value as well.
The best way to optimize your executive compensation benefits is to fully educate yourself on the options available to you. Your advisor can play an impactful role in designing the right strategy around your goals, even as executive compensation continues to change rapidly. In just the last several years, there have been legislative changes that impacted how options are accounted for in company books, making them less widely used than they were in the past. However, as pension plans become less relevant and defined benefit plans start to be eliminated at large companies, many companies are seeking new alternatives to provide compensation to employees, including through unique benefit options.