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Strategies & Market Trends : Employee Stock Options - NQSOs & ISOs -- Ignore unavailable to you. Want to Upgrade?

To: hueyone who wrote (14)	6/11/2002 9:44:09 AM
From: Clarksterh	Read Replies (2) \| Respond to of 786

If the company sold the same shares to the public and then used the money to pay workers, it would be an expense under anyone's definition. No, there would be two entries under cash flow and earnings - one for the cash coming in from the sale of stock, and an exactly equal one for the compensation going out. It would effect earnings not at all except that there would be dilution. Denying something is income or expense simply because cash doesn't change hands on one side or both doesn't wash. If your company gives you a new Mercedes Benz tomorrow, try telling the IRS it isn't income. Funny that Steve Jobs had to report that 90 million dollar jet that Apple gave him as income. According to your rationale, he didn't get any cash, so he must he must not have any income. ... First, contrary to what you claim as per your examples, no one here is denying that it is income to the recipient. The question is how the company treats the gift. The answer is that it hits cash flow (and earnings) directly only to the extent that it costs them anything. If Apple got the jet for free and then gave it to Jobs, it would not show up on the cash flow at all except possibly for the indirect effects due to taxes. Hopefully the analogy here is clear enough. Which brings the question to mind again that you and Ron have never answered---Why does the IRS so readily recognize this expense that you and Ron call a phantom expense if it so obviously a phantom expense. I wasn't aware that it was so easy to just make up expenses to the IRS on the company reports. This has been addressed multiple times (I'm sorry you don't understand). It is a form of corporate welfare; a way to give money to a company and as such I think it should be removed. Note that this is in point of fact the one and only way that stock options effect cash flow and once removed the stock options would have absolutely no effect on cash flow. Clark

To: hueyone who wrote (14)	6/11/2002 10:14:10 AM
From: rkral	Read Replies (2) \| Respond to of 786

A "value flow" diagram for the option exercise. Huey, I recently sketched the following diagram, and have kept it posted near my computer ever since. For lack of a better term, I call it a "value flow" diagram. Dang! The SI graphics still isn't working. You'll have to help me out by sketching it for me. Using a full 8" x 11" sheet of paper: write "company" at top center, write "employee" about 2 inches below company, write "mr market" to the extreme left of employee, and write "uncle sam" to the extreme right of employee. Assume employee has a non-qualified stock option for 1 share granted by company many years earlier, exercise price of $10, mr market has priced company stock at 70 on the exercise date, employee marginal tax rate of 33 1/3%, and company effective tax rate of 33 1/3%. The employee decides to exercise and cash in on that $60 intrinsic value of his option .. so let's draw some value flows on the diagram. For each one of the following, draw an arrow from the "from" to the "to" and writing the "value" next to the arrow: "value" from "from" to "to", a generic example; $10 from employee to company; "1 share" from company to employee; "1 share" from employee to mr market; "$70" from mr market to employee; and "$20" from employee to uncle sam. Let's pause and examine what we've drawn. Other than the tax benefit, IMHO we've drawn EVERY value flow for these entities attributable to the option exercise. Examining the net for each entitiy: (1) the net of value flows to/from the employee reveals that the employee had a $60 gain (which IRS calls ordinary income) on which the employee pays $20 tax to net $40 after-tax income; (2) the net for uncle sam is the $20 tax from the employee; (3) the combined value flows for the company, a capitalization transaction, increase shareholder equity $10 and increase shares outstanding by 1. (4) the net for mr market is what it is. IMO, not only is the diagram accurate, it is "fair". The employee has paid a "fair share" of taxes and uncle sam ended up with the tax in his pocket. Now using a dashed arrow on the diagram, show a value flow of $20 from uncle sam to the company. This represents the tax credit (an actual cash flow) permitted by the IRS for "employee compensation expense". The tax credit value flow is real because it is permitted. But does it make sense? Where is the $60 compensation expense flow from the company to the employee? If we showed that on the diagram, would THAT make sense? And is it fair? Why should the IRS net be $0? (This is exactly the case only when employee and company tax rates are equal. In general, the IRS net may be positive or negative.) Ron