Comparison of Three Different Types of Equity Compensation1.Traditional Employee Stock Options2. Restricted Stock3. Dynamic Employee Stock Options
Before I can make a good comparison, I wish to state four objectives ofthe grants that are most relevant to the comparison:1. The First objective of a grant of equity compensation is to align thelong term interests of the employee or executive with the interests ofthe shareholders.2. The Second objective is to attract high quality long term employeesand executives while preserving cash and enhancing cash flow.3. The Third objective is to accomplish the first and second objectiveswithout too much dilution of earnings and with as little real andtheoretical costs.4. The Fourth objective is to make the plan understanable to thegrantees and allow efficient risk and tax management by the granteesand to allow the grantee to maximize his/ her returns.
Traditional Employee Stock Options (non- qualified)a) Aligns Interests of grantees with shareholders temporarily untilexercises and sales eliminate any alignment perhaps encouraged bypromoters of early exercise, sell and "diversify" strategies.b) Awards a non-taxable value to the employee upon grant. Taxes aredue upon exercise not vesting as in Restricted Stock.c) Attracts long term highly qualified loyal employees.d) Preserves company cash and upon exercise creates major cashflows to the company from tax credits and payment of exercise priceby employees.
e) Efficiently reducing risk because of non transferrability, nonpledgability requires hedging by employee. The strategy of prematureexercises, sell and diversify has penalties that are near impossible toovercome in most cases.f) Exercise price possibly can be repriced if stock declines significantly.g) High chance of loss of 100% of grant valueh) Greater up side potential for ESOs per dollar of "fair value" grantedcompared with restricted stock.i) Greater potential earnings dilution with ESOs grants if "fair value" ofESO grants are equal to the "fair value" of Restricted Stock.
Restricted Stocka) Aligns Interests of employees with shareholders until vesting andsale of stock. Usually 100% is sold immediately after vesting, whichends all alignment.b) Awards a non-taxable value to the employee upon grant. Vestingcauses an immediate tax liability.c) Attracts long term highly qualified loyal employees.d) Preserves company cash and creates early major cash flows tothe company from tax credits upon vesting but not from payment ofan exercise price by employees as with ESOs. Grantees generallypay an earlier tax with Restricted Stock grants.
e) Restricted Stock are less volatile than ESOs and do not erodeover time.f) Less potential dilution occurs per dollar of "fair value" grantedcompared with Dynamic ESOs and TESOsg) Risk of 100% loss value is far less than risk of loss on ESOs.h) No repricing possible with restricted stocki) Easier to understand by executives and employees and easier torisk manage because there is no extra penalties to sale aftervesting in the form of forfeited "time value" or early payment oftaxes upon vesting.j) Restricted Stock may not be fully exempt from IRC Section 162(m)
Dynamic Employee Stock Optionsa) Aligns the Interests of employees with shareholders for muchlonger periods than traditional ESOs. The extra costs to thecompany are incidental.b) Awards a non-taxable value to the grantee on grant day. Taxliability occurs on exercise not upon vesting and is 25% less thanTESOs.c) Attracts long term highly qualified loyal employees with a superiorequity compensation plan compared to traditional ESOs or RSs.
d) Preserves company cash and increases early cash flows to thecompany from tax credits and sale of stock as employees will exercisemuch earlier since early exercises are penalized only incidentally.e) Allows for a simple highly efficient risk and tax management method by theemployee by reducing the penalties of early exercises and salesf) Greatly reduces the need for hedging with calls and puts and reduces theopportunities for gaming exit strategies.g) DESOs are better for the company and better for the employee comparedwith ESOs or RS, although DESOs are a bit more complicated.h) DESOs make the Wealth Managers job a lot easier because when theWealth Manager advises early exercise, sell and diversify, he eliminates anyclaims of fiduciary duty violations.
Summary:We have illustrated that Dynamic Employee Stock Options arefar superior to Traditional ESOs and far superior to RestrictedStock as an Equity Compensation vehicle.See the link below for more details on Dynamic Employee StockOptions.http://www.slideshare.net/OLAslideshare/dynamic-equity-compensation-plan-6http://www.slideshare.net/OLAslideshare/new-dynamicemployeestockoptionspresentati-4-12038997