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We at myStockOptions.com have seen a lot of changes since we launched the website back in June 2000. As part of our 10th-anniversary celebrations, this article reviews, in chronological order, the top five issues and developments in equity compensation that we have witnessed and covered over the past decade. Let's take a break, look back, and have some fun.
Number One: The Democratization Of Stock Options In The Dotcom Era
For most of their quiet history, stock options were an elite form of equity compensation, largely for senior executives and directors. As everybody knows, this changed during the 1990s. Technology startups and other fast-growing companies found that stock options perfectly suited their need to attract and retain bright talent on a low cash flow. The lure of stock option wealth after a successful IPO helped many of today's top technology companies expand and flourish into the giants they are today.
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The tech boom democratized stock options, bringing them down from the lofty heights of Mt. Executive into the workaday world of middle-class people. |
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By 1999–2000, when myStockOptions.com was developed and launched, there was a frenzy over stock options in the tech industry. Our files of news articles from that time reveal vibrant references to ambitious employees who "crave" or "lust for" stock options. The wealth-building leverage of options was expressed as "the stock option dream." In Silicon Valley, the biggest market for tech options, newspapers such as the San Francisco Chronicle and the San Jose Mercury News assigned reporters expressly to cover the stock option beat. In their pages, articles on option financial planning became as normal as tips on home-buying or personal banking.
This business trend democratized stock options, bringing them down from the lofty heights of Mt. Executive into the workaday world of middle-class people who in an earlier era might never have heard of them. And it wasn't just the technorati who derived the benefits. Many "stock option millionaires" included people not on the front lines of technological innovation. For example, one of Google's in-house masseuses became a millionairess from stock options granted to her in 1999.
myStockOptions.com was born into a world where options, and other forms of stock compensation, had the potential to change anybody's life. You no longer needed elite family or business connections: just the right equity incentives and a lot of honest, hard work. Equity comp had become a wealth-builder for the masses, both in the United States and elsewhere in the world.
Number Two: The Downturn Of 2000–2002, Mandatory Option Expensing, And The Rise Of Restricted Stock
Long before the recession of 2008–2009, the phrase underwater stock options had become painfully known to many people and their companies. The stock market downturn of 2000–2002 revealed one of the weak points of options: they were, at least temporarily, worthless if the company's stock price fell below the exercise price of the options. However, after the options-fueled growth of the 1990s, much of corporate America had come to depend on robust equity incentives to draw and keep the brainpower they needed.
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From the ashes of the downturn, restricted stock and RSUs were born. |
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As a result, talk turned to alternatives for stock options. The expected change in accounting rules that finally came with FAS 123(R) (now called ASC Topic 718) also encouraged this discussion, as soon all grants would need to be expensed on the company's income statement instead of merely appearing a footnote. Now that stock options were losing their favored accounting treatment, companies had an additional financial incentive to consider other types of grant that could fit their approach to compensation.
Many types of equity award were bruited about, but one in particular was taken up widely. From the ashes of the downturn, restricted stock was born. Like stock options, restricted stock had previously been an obscure form of senior executive compensation—not a pay practice for lower-level executives or regular employees. However, it emerged into the corporate limelight in 2002 as the best broad-based alternative to stock options because, as a "full value" award, it was downturn-proof: a grant of restricted stock is always worth something (unless the stock price falls to zero). In fact, many observers foretold that restricted stock would become the new stock options.
They were half right. As events have unfolded, it is the unidentical twin of restricted stock—restricted stock units, or RSUs—that has become the most popular alternative to stock options at many companies. You are now more likely to receive RSUs than restricted stock. The use of restricted stock and RSUs at companies has continued to grow. While not granted as broadly to employees as stock options were during their heyday, they have joined stock options among the top forms of equity compensation.
We at myStockOptions.com spotted this trend as it became evident during the downturn of 2000–2002. Our coverage of restricted stock and RSUs may, in fact, now rival or even exceed our coverage of stock options. While myStockOptions.com has become our trusted brand name, we could just as well be called myRestrictedStock.com (in fact, we own the URL!). This is no exaggeration: our varied content on restricted stock/RSUs includes articles, FAQs, podcasts, calculators, quizzes, and even self-study courses for continuing education credits. myStockOptions.com also has special tools dedicated to financial planning with restricted stock and RSUs.
Number Three: Backdating
After the market downturn of 2000–2002, there unfolded a series of corporate scandals and government responses to them. These began with Enron and the subsequent passage of the Sarbanes-Oxley Act of 2002. A few years later, it was the turn of stock options to become a topic of wide public controversy: the uproar over backdating.
In the early years of the decade, the Securities and Exchange Commission (SEC) seemed to be focusing on the "springloading" of stock grants, i.e. the timing of grants to occur just before the release of good news that pumped up the company stock price. Then, in 2004, its focus changed. Suddenly, the SEC and local prosecutors shifted their glare to the corporate practice of backdating stock option grants to give them a lower exercise price than the fair market value of the company's stock on the actual date of grant.
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The backdating scandals shook the world of stock options, which became a media dartboard on which everybody could pin the blame for executive greed. |
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The investigations and prosecutions that followed shook the world of stock options from top to bottom. After enjoying praise in the news media as everyman wealth-makers during the sunshine years of the 1990s, stock options became a media dartboard on which everybody could pin the blame for executive greed and finagling.
The first big backdating case, in 2005, involved an admission of backdating grants at a major company and the mere resignation of its CEO and two other executives. However, in July 2006, things got more serious: SEC and the US Attorney for Northern California brought the first criminal backdating case. Others followed. In 2007, the SEC announced its first penalties directly against companies and executives. More penalties followed in the subsequent months. A report on backdating by the Congressional Research Service noted that the SEC had 80 cases under investigation by November 2007 (the peak was 160), and that the SEC had charged seven companies and 26 former executives associated with 15 firms. As for criminal cases, it mentioned at least 10 criminal filings.
Although the four-year backdating uproar was finally drowned out by the noise of the stock market crash and economic downturn in 2008–2009, it has continued to echo resonantly. As recently as January 2010, a former vice president of human resources was sent to jail after being convicted for her role in backdating at her former company. Another executive was convicted of backdating-related fraud in April 2010.
While our coverage of the backdating scandal remained largely limited to its impact on corporate practices and individual taxation, myStockOptions.com has been watching this soap opera for six years. It has been amazing for us to see, for better or worse, stock options in front-page headlines of major newspapers. While the backdating saga tarnished the reputation of stock options, it did at least improve the administrative process for granting them at many companies.
Number Four: The Politics Of The Alternative Minimum Tax
As our members know, we at myStockOptions.com are close followers of the sometimes fast-moving legislative developments affecting the alternative minimum tax (AMT). This is a topic of great importance to employees with incentive stock options, as the spread at the exercise of ISOs is part of the AMT income calculation. Every year since 2003, myStockOptions.com has watched and covered the political battles in Congress over the issues of paying for AMT relief.
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The issue of paying for AMT patches became an annual tug-of-war between Democrats and Republicans in Congress. |
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Now notorious, the AMT was enacted in 1969 to stop extremely wealthy people from dodging their tax liabilities. However, for various reasons, the reach of the AMT has expanded over time to hit middle-income people it was never intended to tax, including people who exercise and hold ISOs. To check the spread of the AMT, Congress began enacting temporary tax relief several years ago (and in 2008 adopted a special AMT credit for those burned during the stock price drops in 2000–2002). The tactic has been to raise the AMT income exemption amounts slightly each year in accordance with inflation. Without these annual "patches" to control the spread of the AMT, the AMT exemption amounts would return to the low levels of 2000, imposing the AMT on 30 million middle-income taxpayers it was never intended to tax.
The issue of paying for these AMT patches, without adding to the national deficit, became an annual tug-of-war between Democrats and Republicans that had become predictable by 2007. Every time Congress considered an annual AMT patch, or even the elimination of the AMT, Democrats proposed to pay for the resulting revenue shortfall, and thus meet budget spending, by raising taxes elsewhere. However, Republicans rejected the idea of tax hikes because they felt these might damage the economy. Democrats retorted that raising tax rates for big business and the wealthy would be better than worsening the federal deficit. Back and forth it went.
For the first time in federal budget planning, President Barack Obama's initial budget projection in February 2009 formally included the continuation of these annual AMT patches, indexed for inflation. Whether this will pass remains unclear, as we still do not have a patch for 2010, let alone an automatic patch. However, the honest recognition of annual AMT patches, indexed for inflation, in federal budgets would remove the disparity between assumed and actual AMT revenue, and by extension would remove any need to discuss offsets to pay for AMT relief.
Nevertheless, no matter what Congress does with AMT relief, for anybody with ISOs the AMT will continue to require extensive tax planning to minimize its painful impact.
Number Five: The Rise Of Pay For Performance
Right from the start of broad-based grants of restricted stock and RSUs, one of the recurring groans about these grants was that vesting was based entirely on time: receiving the shares was usually contingent on nothing more than continuing to work as an employee of the company. This gripe is most famously encapsulated in the phrase "pay for pulse," which has become a plaintive refrain among shareholders dissatisfied with time-based vesting.
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The answer to "pay for pulse" has become "pay for performance." |
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The answer to "pay for pulse" has become "pay for performance." Over the past few years, myStockOptions.com and other observers in the equity compensation arena have charted the rise of performance shares or units among long-term equity incentives. These grants typically resemble grants of restricted stock or RSUs but require more than just continued employment before they vest: the company must meet stipulated performance goals during a stated period after the grant. In addition, some companies have added performance requirements even to grants of stock options.
While stock options and restricted stock remain important for corporate recruitment, retention, and motivation, performance shares both make investors happy and create a stronger link between pay and performance. In fact, for senior executives they have become almost mandatory as a sign that the company is trying to improve the alignment of pay, performance, and long-term shareholder value. Now companies are starting to grant performances shares beyond a narrow group of key executives who steer a company's long-term success. Outside the US (e.g. in the United Kingdom), these grants have fairly common for a while.
The "pay for performance" trend has been one of the most interesting developments in stock-based compensation during the past decade. We continue to cover its evolving aspects in a special section dedicated to performance shares.
Next Decade
What will follow in the new decade? Perhaps the next big impact for equity compensation will come from the tax increases scheduled to start after 2010. Another issue to consider is the likely introduction of international accounting rules (IFRS) in the US, and the continued assault on everything related to executive compensation. Meanwhile, stock plans will continue to become more global, and equity compensation will become more available to employees throughout the world.
Other developments, perhaps less foreseeable, are sure to emerge in the coming decade. During that time, myStockOptions.com will remain your best resource for staying on top of developments affecting the financial planning, taxes, and wealth-building potential of stock compensation, whether stock options, restricted stock, performance shares, or employee stock purchase plans.
Matt Simon is the Editor & Content-Manager at myStockOptions.com.
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