Hi Peter, I'm back.
Picking up where we left off, you wrote: I have no problem with this formula, Cost = A/N - (A+S*n)/(N+n), as it represents the reduction in claim on company assets, for existing shares, caused by employee option dilutive affect.
And let's return to our disagreement. Because the temptation of your logic has lead me briefly astray into the vagaries of "opportunity cost". Apologies.
Let me start again.
The problem with using market price can be demonstrated by price movement in the last month. Market price has dropped 25% in the month, so options exercised 30 days ago would have a 25% higher cost to shareholders than options exercised today, using your original formula.
Yes. Options exercised at a higher price have a higher cost to shareholders than options exercised at a lower price. But this is NOT a problem. It is merely a fact. You should expect this!!
Important not to confuse what folks gain or lose because the market fluctuates with what folks gain or lose because of option exercise. Must separate the two effects.
Let's see what happens when some employee exercises 1000 shares worth $18 in assets each (post dilution) to some hypothetical shareholder Hudson for $40 each. If you don't like my numbers, feel free to substitute your own ;)
Anyway, using my numbers, Hudson is suddenly holding $22,000 in very real cost that just hasn't yet come home to roost. That is, $40,000 in cost only nets him $18,000 in assets.
Now, in the future, he could hold on until they reach $18 each in present value. Or he might be clever enough to sell these shares to someone much more bullish for $60 each. Who might then moan "blah blah blah, therefore sell QCOM" on a daily basis and still not do so, riding the shares down and up and down and up and down, eventually to settle at $18 or so. This poor soul will eat $42,000 in loss against Hudson's $20,000 gain, but the net effect between them is still a $22,000 loss.
Or instead maybe give up in disgust during a depressing interval of very depressed prices, and deliver them into the patiently waiting hands of Shannon at $15 each, to lose $25,000 to Shannon's $3,000 gain...
Or any number of scenarios in between.
In the end, the employee walks away with $40,000 and shareholders walk away with $18,000 in assets and distribute the remaining $22,000 loss amongst themselves through subsequent trades much like a hole moves through a semiconductor lattice, neither being created nor destroyed. Just shuffled along.
When the shares are issued and FIRST sold into the market, there is a pending gain or loss created to the extent that the shares are sold at a price below or above the "fair" value.. Every subsequent transaction merely apportions the ownership of this gain or loss between the various intermediaries. I think you can try out any number of 'before and after' scenarios with any number of intermediate trades. When you add up the gains and losses for all participants, if you've done it correctly the sum will net to the difference between 'fair' price at the moment of exercise and market price.
This is OVER AND ABOVE the cost of dilution that creating the shares themselves imposes on shareholders. We calculated that separately.
So in addition to dilution cost, I think you can see that there is a Market Mispricing cost of [P-F] per option, where "P" represents market price, and "F" represents fair market value. However, unlike the dilution cost which is borne by ALL shareholders, this Market Mispricing cost is borne only by the purchasing shareholders and is not spread out amongst the existing shareholders. Their holdings are not affected by the market price.
What do you think?
John |
