scottsdale, az may 19-22, 2015 - equity methods
TRANSCRIPT
SCOTTSDALE, AZ MAY 19-22, 2015
Are They Coming Back? Brush Up on
Stock Options
Robert Slaughter, Equity Methods
David Outlaw, Equity Methods
Aaron Boyd, Equilar
CPE Credits
Continuing Professional Education (CPE) Credits are Available!
You will receive one (1) CPE credit after attending this session
You must attend the entire session to be eligible
In order to earn the available credit(s) for this session, you must see
the room monitor at the end of the session to officially sign-out
Electronic certificates will be emailed to you a few weeks after the
conference with the cumulative number of credits earned
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Agenda
A brief history of options
Trends in option grants
Why grant options?
Option valuation
Taxes
Shareholder considerations
Option variants
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A Brief History of Options
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Ancient Greece: olive speculation
1800s: OTC trading
1973: Black-Scholes published; CBOE opens
1980s-90s: ESOs become common.
They’re “free!”
Late 1990s: Dot-com boom, everyone’s a millionaire!
Early 2000s: Dot-com bust, not so enthusiastic
2006: FAS 123R: They’re not free
anymore
2008-09: Market crash, underwater
options
Today: Back on the rise?
An Example
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Grant: $180
Vest
Exercise: $410
Profit = $230!
Strike price
Methodology
Equity mix information
▪ Sample of 304 S&P 1500 companies with
data from 2014
▪ Results in line with those of full S&P 1500
samples available for prior years.
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Equity Mix – Options and Stock Balance
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Source: Equilar, Inc.
25th Percentile
More than three quarters of equity value is currently being granted in full value shares
like stock and units. In 2009, the balance was almost 50-50.
49.46%
41.65%
32.90% 26.65% 24.65%
21.26%
50.54%
58.35%
67.10% 73.35% 75.35%
78.74%
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
2009 2010 2011 2012 2013 2014
Option Value % Stock Value %
Equity Mix – Value of Annual Grants
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Source: Equilar, Inc.
$4,466
$4,020 $3,575 $3,358 $3,396 $3,299 $3,782
$5,902
$8,002 $9,195
$12,502
$14,306
$10,574 $12,034
$14,037
$16,663
$18,411 $19,344
$0
$5,000
$10,000
$15,000
$20,000
2009 2010 2011 2012 2013 2014
Tho
usa
nd
s
Option Value Stock/Unit Value Total Equity Value
The median total value of options granted has declined by 26% while total value of
stock/unit awards has increased by 278%. Total equity granted has grown by 83%.
What Is Driving These Trends?
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• Lower dilution and better performance alignment expectations Investors
• Recommendations against equity plans with high dilution Proxy Advisors
• Easier to understand restricted stock and more motivating Employees
What Are The Company Concerns?
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Dilution
Equity plan costs
Pay for performance alignment
Motivation
Retention
Options & SARs – Annual Grants
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Source: Equilar, Inc.
0
200
400
600
800
1000
1200
1400
1600
1800
2000
2007 2008 2009 2010 2011 2012 2013 2014
Tho
usa
nd
s
The amount of options being granted has been decreasing for a decade except when
the market fell in 2008 & 2009.
75th Percentile
50th Percentile
25th Percentile
Stock Price
$34
$29
$25
$30
$35
$38
$46
$54
S&P 1500 Equity Mix
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Source: Equilar, Inc.
66% 67% 69% 70%
65% 64% 62%
65%
11% 15% 16%
18%
24% 26%
31% 29%
19%
12% 9% 9%
7% 6% 6% 4% 3% 3% 2% 2% 3%
1% 1%
2007 2008 2009 2010 2011 2012 2013 2014
Percentage of Companies
Pe
rce
nta
ge o
f C
om
pan
ies
Both
Only Restricted Stock
Only Options
Neither
Companies are switching to full value shares and away from options but most are
still maintaining a mix.
Options: A Piece of the Puzzle
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Options
You
Comp
Portfolio
Why Grant Options?
Much more “bang for the buck” when growing ▪ Lower cost means many more can be granted
▪ Upside is still 1:1 like an RSU
They are true long-term incentives ▪ Most LTIPs cover only three years
▪ Options typically cover 7-10
No reward for negative performance ▪ Good fit for executives with line-of-sight to stock price
performance
As an equity-based instrument, no cash is required from the issuing company
Attracting and retaining top talent ▪ A standard part of the comp package in some industries,
just like health insurance is
▪ High payout potential is attractive to high performers
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Why Leverage Can Be a Good Thing
Above a certain stock price, the higher number of option shares is more
valuable than the equivalent in full value RSU shares
This makes it a great instrument to issue in growth scenarios
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RSUs more valuable Options more valuable
Option Valuation Basics
Here are the basic inputs needed to estimate the fair
value of an employee stock option:
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An increase here… … changes fair value What can you do about it?
Grant price (at the money)
Expected term
Volatility
Risk-free rate
Dividend yield
Not much; stock price on grant date
Contractual term, vesting schedule
Nothing directly; consider implied volatility
Nothing; very mechanical
Nothing (for the people in this room!)
Tax…a simple, unified perspective
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Perspective Grant Date Vest Date Exercise Date Sale Date
Corporate
Expense Start expense
Stop
expense Doesn’t care Doesn’t care
Corporate
Tax
Going to save
some tax later
(an asset)
Doesn’t
care.
Time to
recognize that
tax benefit.
Doesn’t care.
Personal Tax Doesn’t care. Doesn’t
care.
Asset is
“bought” at
strike price
Asset is sold
Lots of people care about the life of an option, and it’s
confusing…because they all care about different things
The Unexpected
What happens when the unexpected happens?
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Termination Event Type Considerations
Retirement Voluntary • Do options accelerate? • Retirement eligibility plays a role before retirement actually
occurs
Resignation Voluntary • Usually lose options
For cause Involuntary • Usually lose options
Not for cause/Good Reason
Involuntary • Depending on terms, may keep, accelerate, pro rata payout
Merger/Acquisition Involuntary • Options assumed by new entity? • Cash payout?
Disability/death N/A • Various
Shareholders’ Perspective
Shareholders have a unique set of considerations for option grants
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Shareholders
Regulators Participants
How does this increase our return?
How will this change my total compensation?
How do these affect the public?
From the shareholders’ perspective
Options are great, but unfortunately they aren’t free
▪ It can be complicated to figure out how much options
(equity compensation in general) hurt shareholders
▪ Dilution issues
▫ Diluted earnings per share
▫ Options overhang
▪ Governance groups
▫ Options are not “performance based”
▪ Investors
▫ Are options expense really something we care about? After
all, it is just “accounting”
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Dilution is a necessary
downside of granting
equity
Vanilla Too Boring? Lots of Other Flavors!
If you want the benefits of options but you prefer something less one-size-fits-all, there are plenty of variations you can add
Out-of-the-money options
Performance options
▪ TSR based: relative or stock price hurdle
▪ Performance based: operational target or major milestone (IPO, drug approval)
SARs (cash-based)
Various combinations of features
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Questions?
Contact Us
Robert Slaughter
Senior Consultant
Equity Methods
Phone: 480.428.3308
Aaron Boyd
Director of Governance Research
Equilar
Phone: 650.241.6655
David Outlaw
Manager, Valuation Services
Equity Methods
Phone: 480.428.3305
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