Re: 100,000 employee analysis
Thanks for correcting my mistake. You're right that I omitted the exercise price payment by the employee. I needed a sanity check that works as well as the IRS!
The company gets a tax deduction for the same amount as the employee picks up in income. Using a 40% tax rate, they save $7,733, and the IRS nets zero.
You omitted the advance payment the company made to the IRS at the time it sold the option to the employee. They recorded $90,000 of expenses rather than $100,000 and paid the IRS much more money than they really owed. Nobody gets away without paying taxes and the IRS always wins! The tax deduction the company receives when the option is exercised is a refund for the excessive taxes paid when the option was sold to the employee.
I agree with you that B-S results in fewer shares as the option term is extended. However, if you want to use a ten year term, I would argue that the stock could easily more than double during the option term.
The stock will double in 10 years even if the company has a mediocre performance. Stock options are intended to reward average or above average performance and punish mediocre performance, but a 10 year term practically guarantees the employee a positive return for attendance regardless of performance.
Everyone loses if the stock goes down; the company, the employee,, and the outside stockholders.
The IRS is the silent partner of all 3 groups, so don't forget that they lose, too. As U.S. taxpayers, our top priority should be to make sure that they are a winner.
In 1996, when they granted boatloads of options without offsetting purchases, I don't believe they had a cash position that made it prudent for them to fight the dilution.
The massive dilution was greater than the reported earnings. In other words, they lost money, and that doesn't portend well for the future ability of the company to make profits. Selling options was probably a wise decision, but they sold too many at a low price. See the analysis of the hypothetical $100,000 employee below for details.
Actually, this whole discussion of options has little to do with the original question that started the topic, which was not whether or not WIND should grant options. It was whether the level of options is excessive, since options are a fact of life.
The company granted 1,991,000 options in FY-98 and 755,000 of them went to the 6 top executives, leaving 1,236,000 for the remaining 432 employees. The average non-executive employee received options on 2,861 shares and our hypothetical $100,000 employee has an average salary and received 2,861 options (not 537 or 369). The average exercise price is 33.54 and the current value of the options is $80,767 (stock price = 37.375, interest rate = 6%, volatility = 60%, time = 9.5 years).
His fair rate of base base is $19,233 and the probability of that is remote, so he's wildly overpaid. His base pay is at least $70,000, so his total compensation is much more than he's worth.
Our hypothetical $100,000 engineer is guaranteed a fabulous return for merely average performance. The average stock appreciates 12% annually and that performance will raise the price of Wind River from 37 3/8 to 109 5/8. He'll sell his options for $313,813, pay $95,958 to the company for the exercise price, $87,142 to the IRS, and keep $130,713 for himself. The present value of his portion is $72,989 for 10 years at 6% interest. He paid at most $30,000 for his shares, so he has a huge profit for merely average performance and he'll break even if the shares rise 3.6% annually. He'll become a millionaire as long as he stays at the company for 10 years, receives options each year, and the company isn't mismanaged on a grand scale.
The 6 top executives that received 755,000 options will become fabulously wealthy. The outside stockholder might be unhappy if his friends invested in index funds and received the same 12% annual return.
I'm bullish on WIND; if I wasn't, I'd be posting on another board.
I prefer your input regardless of your trading position. Too many other threads are support groups for longs or shorts, or attract legions of flamers like Mitchell Jones. The quality of substantive posts has risen dramatically on this thread the last couple of months. You'll be missed if you leave. |
