Stagger-
Granted, under an options plan there is no change in total market cap, but who cares? The point is, share price suffers. Existing shareholders LOSE and the new shareholders (i.e., management) win, just as if the awards to management had been made in cash, as in a SARS plan.
You've never actually looked at numbers, have you? You just see that both events have a negative effect on share price and figure that they must be equally as bad, eh? Well, here's an example for you, showing why Options are so much better than SAR's that if IATV switched to Options as incentive compensation and dropped SAR's, we should all be dancing a jig.
On Jan 1, Stock A and stock B both have 100 million shares outstanding at a price of $10 at the beginning of a quarter. Total Market cap is $1 Billion. The trailing P/E ratio of these companies is 100 because they're both young internet companies. This means that the companies had $10 million in profits last year. Both companies have $20 million in cash and equivalents on hand.
Stock A issues a total of 10 million stock options to their employees with a strike price of $10. Stock B issues 10 million SAR's to their employees. Because price at end of 4Q was $10, these SAR's are also priced at $10.
Now fast forward to the next December 30, when every employee exercises their options and their SAR's. Assume 1-year vesting for the options (which never happens, but anyhow) and 1-year vesting for the SAR's. Thus the impact of the option exercise/SAR exercise will hit the bottom line in the 4Q and affect 4Q numbers and subsequent pricing.
Say that the company as of December 29 had made $20 million in profits this year and there was no other dilution during the year. Thus, the markets have both stocks at $20 on December 29 (P/E stays at 100).
On December 30, company A issues 10 million shares of stock to cover the option exercise, and receives $100 million in cash from the employees to purchase that stock (employees do have to buy the stock from the company before they can sell it. You did know that, right?). Company B has to pay out $100 million in cash to cover the SAR's. Assume that every employee who exercised an option sold the stock on the open market that same day, and that the price stuck at $20 regardless. So, for each option held by the employee of company A, that employee made $10. (Bought at $10 from company, sold at $20 on open market the same day). For each SAR held by the employees of company B, the employees made $10 (because that's how much the stock appreciated). So the employees get the same $ either way.
So on January 1, the 4Q numbers come out. Let's see how company A and company B are faring on the balance sheet, shall we?
Company A - earned $20 million in profit, had $20 million in cash on hand to start with, and the employees who exercised their options paid $100 million to do so. (Strike price = price that you can purchase the stock for, and you purchase from the company). So Company A has $140 million in cash on hand, but diluted so that they have 110 million shares outstanding. At P/E of 100, market cap would be $2 Billion, so stock price falls from $20 to $18.18.
Company B - earned $20 million in profit through December 29, but had to pay out $100 million in SAR's on December 30, causing the company to lose $80 million for the year. Company started with $20 million in cash, so the company is now bankrupt. Even if they find a way to secure financing (other than by issuing new stock), the P/E ratio is now negative and in all likelihood the stock plummets from $20. After all, the reason the stock was priced at $20 was based on the profit the company had made, but they made a $10 million profit last year and turned that into an $80 million loss, and that doesn't look too good. In all likelihood you can buy this stock for pennies. If you think this is harsh, flash back to posts I made in March criticizing exec compensation plan and showing that the SAR's would prevent IATV from EVER turning a profit, because the promise of profit would bump up the share price, and the SAR's would always be valued at more than what the profit would have been, so the company would always lose money.
Now, there is one exception to the rule that says Options are better. If the company does not have the ability to issue new stock to cover the option purchases (because they are at or near their authorized limit) and they then have to buy the stock on the open market to sell to their employees, then options are just as bad as SAR's. Why? Because the company has to lay out a bunch of cash, and that's the problem with SAR's. However, companies know that this is bad, and that's why at every shareholders' meeting just about, the companies ask for an increase in authorized shares. This is to cover two things: Employee incentive options and stock splits. Authorized share increases are almost always approved.
There, I hope that the numbers convinced you. You can change any variable you want and, so long as the number of SAR's issued equals the number of options issued and the company doesn't have to buy stock on the open market to cover the options exercise, the company issuing options will come out ahead.
-Mike |
