I was recently asked to comment on a premium priced option granted to IBM’s CEO for an article in Bloomberg (“IBM Says CEO Pay Is $33 Million. Others Say It Is Far Higher“). There are a number of things that I find interesting about the grant.
The Option Grant
The option was granted to IBM’s CEO and is for a total of 1.5 million shares, granted in four tranches. Each tranche cliff vests in three years and has a different exercise price, ranging from $129.08 to $153.66 (premiums ranging from 5% to 25% of FMV).
The option was granted in January of last year, about a month before IBM’s stock price hit its five-year low. IBM’s stock price recovered to the point where all four tranches were in the money around mid-July and the option has mostly been in-the-money since then. IBM’s stock is now trading at around $160 (down from a three-month high of around $180). Either the options were very effective at motivating IBM’s CEO or IBM didn’t set the premiums high enough (or both).
The option doesn’t vest until January 2019 and we all know what can happen to any company’s stock price in that period of time, so there’s no guarantee that the option will still be in-the-money when it vests. The option has a term of ten-years, however, so if it isn’t in-the-money, there’s still plenty of time for the stock price to recover before it expires.
A History of Premium-Priced Options
This isn’t IBM’s first foray into premium priced options. From 2004 to 2006, IBM granted a series of stock options to its executives that were priced at a 10% premium to the grant date market value. In 2007 they dropped the practice and granted at-the-money options, then they ceased granting options altogether. This is the first option IBM has granted since 2007.
The Valuation Mystery
The reason I was asked to comment on the option is that the value IBM reported for the option (which is also the expense IBM will recognize for it) is significantly less than amount that ISS determined the option was worth. IBM reported that the option has a grant date fair value of $12 million but, according to the Bloomberg article, ISS puts the value at $29 million.
It’s not unusual for there to be variations in option value from one calculation to the next, even when all calculations are using the same model and the same assumptions. But a variation this large is surprising. Both IBM and ISS say they are using the Black-Scholes model, so the difference must be attributable to their assumptions. If I were to guess which assumption is causing the discrepancy, my guess would be expected term. The dividend yield and interest rate aren’t likely to have that much of an impact and it seems unlikely that there would be significant disagreement as to the volatility of IBM’s stock.
Why Price Options at a Premium?
The idea behind premium-priced options is to require execs to deliver some minimum amount of return to investors (e.g., 10%) before they can benefit from their stock options. It’s an idea that never really caught on: only 3% of respondents to the NASPP/Deloitte Consulting 2016 Domestic Stock Plan Design Survey grant them.
I’ve never been a fan of premium-priced options. I suspect that most employees, including execs, assign a very low perceived value to them (or assign no value to them at all), so I doubt they are the incentive they are supposed to be. And the reduction in fair value for the premium is less than the amount by which the options are out-of-the money at grant and far less than the reduction to perceived value, which makes them a costly and inefficient form of compensation.
Tags: ISS, premium-priced stock options
Last week it was widely reported that the founder of Chobani (yes, the yogurt company) became the latest to join a recent trend of CEOs who are sharing their wealth with employees in the form of stock.
Chobani Founder and CEO, Hamidi Ulukaya, committed to give shares to his 2,000 employees equal to an estimated 10% of the company. Chobani is still a privately held company, so its exact present value is not known. But recent estimates put the company’s value between $3 billion to $5 billion.
While such a practice may be more prevalent in tech startup companies, Chobani is in an entirely different industry – the food industry. That’s part of what makes this move by Chobani’s CEO so unique. Sharing equity (especially pre-IPO) in a food company is not the norm, or even common. It’s a rare occurrence. Additionally, Chobani is giving shares to employees after a decade of being in business and after a value has been established, which makes this even more interesting.
In a New York Times article “At Chobani, Now It’s Not Just the Yogurt That’s Rich,” CEO Ulukaya was quoted as saying “I’ve built something I never thought would be such a success, but I cannot think of Chobani being built without all these people. Now they’ll be working to build the company even more and building their future at the same time.”
One Chobani employee’s reaction was also reported in the NY Times article, and it seemed like the perceived value component that every company strives for when issuing equity to employees. When one of the original employees, Rich Lake, was asked about his new shares, he said “It’s better than a bonus or a raise. It’s the best thing because you’re getting a piece of this thing you helped build.” I know HR consultants and stock plan people everywhere are cheering because isn’t that exactly what you want to hear an employee say about their stock awards?
We’ve seen other CEOs handing over portions of their shares to employees in recent months. Hopefully this trend will continue, as more executives see the value of sharing in the equity pie as a team. After all, to sum it up with a sports phrase – there is no “I” in team. And I’m guessing Chobani’s CEO would agree that given the huge success of the company in a decade, the team is well deserving of their stake in the company.
There’s been a theme emerging in some of my recent blogs, covering a wave of companies finding creative ways to expand their equity compensation pool. Last week I talked about the move of Twitter’s CEO to give his own stock back to the company for use in the equity plans. Shortly before that, Apple announced it was giving RSUs to all employees. It seems more and more companies are trying to find ways to expand the equity offering to employees. It seems the Wall Street Journal has also taken notice of some of these efforts. In a recent article (Do Workers Want Shares or Cash?, October 27, 2015), the WSJ explored what do workers really want – stock or cash? The conclusion of the article seemed to be that stock is a tough sell. I’m not sure I fully agree. So in today’s blog, we’ll explore what’s on top? Shares or cash?
Value is in the Eye of the Beholder
Before I answer the question, we need to revisit the concept of perceived value. This, in my opinion, remains a widely underestimated component of truly comparing the merits of receiving cash over stock or vice versa. From the WSJ article, I gleaned some phrases that tell me that there is work to be done in elevating the perceived value of the equity plan. I read things like: [Employee X] “says his shares didn’t make him more likely to stay in his $60,000-a-year job, in part because he was unsure what his stake was worth.” Or, “‘Is this money real and am I really going to get it?’”
On the flip side, and I don’t have data to support it (someone should look into this!), there seem to be companies that have established, on a broad basis, that equity compensation has value – to the point where employees at all levels are requesting more of it. Interestingly, many of these companies offered broad based grants from the point of new hire. Do companies that offer broad based equity from hire do better at upping the perceived value of stock compensation? It’s hard to tell. Perhaps those companies are also more engaged in education and communication, two critical factors in raising the perceived value of equity awards.
From the WSJ article:
At MediaMath, a marketing software company, all employees—including customer-service reps and receptionists—are given stock options designed to equal the amount of their starting salary at the time the shares fully vest. Employees at all levels have requested more equity, and the company recently rolled out new performance incentives that include options.
“We would rather not have the haves and the have-nots,” chief people officer Peter Phelan says. The company is considering an IPO at some point in the future, a move that could bring windfalls for workers.
Online lender Avant Inc. is in the process of implementing policies giving hourly employees the chance to receive equity when they join the company as well as additional grants as part of an annual incentive program. Before, hourly employees were excluded from equity compensation. CEO Al Goldstein says he thinks it will take time before employees trust the perk is meaningful.
“I don’t think it’s a magical thing that happens right away,” he says. Of Avant employees who currently get equity, just 1% have left the company, according to Mr. Goldstein.
Which Wins? Cash or Stock?
Not all companies are valued the same, not all companies have the same stock growth potential, and stock compensation is not necessarily easy to understand if left to the employee to figure it out. For employees who are muddling through those considerations, stock can be a tough sell. Most people don’t want to give up cash to take on something they don’t understand. I think that’s where the key to answering the cash vs. stock question lies – it’s not necessarily that employees want only cash; I think in many cases they want both: cash and incentive compensation that they can understand and value.
Certainly cash may not be the top choice for every scenario. The same goes for stock. I think stock can absolutely be an easy sell to employees…if they are given the tools to appreciate what it means. Ultimately, companies need to pursue what works best for their employee demographics. For companies that are considering more broadly expanding equity programs in lieu of cash incentives, a key focus in mapping a strategic plan should include how to educate employees and raise the perception of the value of the award. And, to the point of one CEO mentioned above, if a company is expanding equity to a broader base of employees, it may take time for the employees to build up that perception of value. It may not magically happen overnight, but with a focus on supporting employees in their understanding and lots of persistence, companies can get there. So in my biased opinion, stock wins. After all, didn’t the turtle win the race?
Tags: perceived value, Plan Design