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

To: Stock Farmer who wrote (27)	6/13/2002 11:06:13 AM
From: rkral	Read Replies (1) \| Respond to of 786

>>Maybe you can do the math for yourself at this point and figure out what it is that it is that Mr. Market owns pre-tax and post tax.<< Easy .. one arrow in, one arrow out .. I can handle that. Mr. Market owns 1 more share of company stock at a cost of $70. No taxable event, pre-tax and post-tax are the same, imho. Ooohh, I see! You want to include equity ownership in this discussion. OK. Using your variables (from posts on other threads) we should end up with equity flows similar (or identical) to what you have presented. Before the exercise, the "existing" shareholder owns shares (N) representing assets (A) (a new $X we don't need) ... and the employee has rights to additional shares (n) at a strike (exercise) price (S). The employee exercises. If the employee holds the stock, the employee becomes a "new" shareholder, i.e., the holder of new shares. If the employee sells, the buyer becomes the new shareholder. A new shareholder may also be the existing shareholder, of course. The total equity value after exercise is A+nS. Their claims to the total equity are based on the ratio of their shares to total shares, N/(N+n) and n/(N+n), respectively. So how did the existing and new shareholders fare? Did they gain, lose, or stay even? (See P.S. for the math.) For N much greater than n, with an error of n/N, the existing shareholder gain is n(S - A/N) and the new shareholder gain is n(A/N - S). The gain for existing shareholders equals the loss (the negative of the gain) of new shareholders .. or vice versa. Not exactly a surprise. Note that the existing shareholder can easily come out of this transaction with a gain. >>And maybe relate the pre-tax numbers to what it is that the employee gets pre-tax. And see if there's some sort of coincidental relationship.<< So now you want to make a connection between equity values and market prices. I think you will have to introduce a metric for that connection. Here's a hint. It's a metric Warren Buffet loves. I will not likely ever accept the P = A/N substitution, as you have presented in the past. Message 17579397. That's like mixing oil and water. Market and equity values don't mix without that missing metric. And then there's another consideration. While the exercise price is the same at grant and exercise, the market price and shareholder equity will likely have changed. Why are values on the exercise date the correct ones to use? Why not those on the grant date? And what about the questions in my "diagram" post? Does the tax credit make sense? Is it fair? Why should there be zero or near-zero taxation on the option exercise event? Ron P.S. The supporting math: EXISTING SHAREHOLDER: The gain (loss) to the existing shareholder is the after-exercise equity value of N shares minus the before exercise equity value of N shares, or: y = ((A + n S) * N / (N + n)) - A which reduces to y = (S - A / N) * n * N / (N + n) which, for N much greater than n, may be approximated by y = n * (S - A / N) NEW SHAREHOLDER: The gain (loss) of the new shareholder is after-exercise equity value of n shares minus the nS cash value added to shareholder equity, or: z = ((A + n S) * n / (N + n)) - n * S which reduces to z = (A / N - S) * n * N / (N + n) which for N much greater than n, may be approximated by z = n * (A / N - S) Note this approximation produces an error of n/N.