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To: geode00 who wrote (16360)	8/2/2002 7:54:27 PM
From: Don Lloyd	Read Replies (2) \| Respond to of 42834

geode00, Question here, when the employee exercises his options, he is considered to have income and owes taxes to the government. Who paid him that income? The exercise price is paid to the company by the employee. The full market price is paid by an unidentified market buyer to the employee. If the employee sells immediately at the current market price, that's the end of it, and the tax is on the difference between the market price and the exercise price. If the stock is held and sold later, there may be an additional tax gain or loss depending on the eventual sale price. Another question here, the company could have in theory sold those shares at the market price. The company isn't getting as much as it could realize so it's on the losing end of this proposition. It's, in theory, buying a happier employee (yeah, right) but it's still paying. This is a widespread misconception on multiple fronts. First, when a company sells its stock at the market, it is an economic non-event from the POV of the shareholder. The shareholder's proportionate share of the sale proceeds is exactly offset by his dilution of ownership. The shareholder ends up with a smaller angular slice of a larger pie, but ends up with the same amount of filling. The net long term effect, of course, depends on the future stock price trajectory. When a company buys back stock at the market, exactly the reverse occurs, and this is also an economic non-event. However, the long term extent of shareholder dilution is covered up. The exercise proceeds are pure gravy to the company itself and partially offset the economic effect of the dilution of the shareholders. Secondly, since one share certificate is no different than another, new shares can be issued and distributed by a company for either secondary issues or employee stock or option compensation with essentially neither limit nor expense, except for minor administrative costs and existing shareholder dilution. Thus, whereas above, it was shown that even if stock or option grants prevented stock sales at the market, it would be without economic consequence. However, here we see that neither stock or option grants actually prevent anything. What if a company were to buy back all its shares (ok, it has a lot of money in the bank) and then distributes all those shares at a lower price than it bought them for to its employees. What happens to shareholders then? All the money in the bank that went out to buy those shares and then those shares are distributed to employees at a lower cost? What shareholders? You just bought them all out at the market. It's nonsensical as far as I can see it. There's a real cost here whether it's actual cash that's not realized or dilution. What am I missing in this argument? What you're missing is that if stock options (or stock grants) are expensed, it represents a double counting of the economic impact on shareholders as effectively both the value of the company itself is claimed to be reduced AND the shareholders are diluted. Stock grants apparently are currently both expensed and counted as dilution, which seems to me an obvious error. Option grants are additionally complicated by the fact that they are not fully counted as dilution. Another side issue is that option grants result in real positive cash flow and economic value to both the company and its shareholders. Regards, Don