There has been much discussion claiming the demise of

Employee Stock Options with Restricted Stock taking over.

Lets compare the two concepts.

1. Restricted stock often has vesting periods similar to the

vesting periods of employee stock options. Perhaps 1 to 5

years. There's not much difference here.

2. Restricted stock generally has no restrictions after the

vesting period. The stock can be sold immediately. Employee

stock options can never be sold and rarely transferred even

after vesting. But employee stock options can be exercised

after vesting anytime prior to expiration.

This difference in liquidity makes restricted stock more

appealing to the employee and less appealing to the

employer. Most restricted stock is sold soon after the stock

vests. The greater liquidity of restricted stock results in 

shorter periods of employee/employer interests alignment,

which to some degree defeats the purpose of the equity grant. 

3. Restricted stock causes taxable compensation income

to the employee when the restricted stock vests, whether

the stock is sold or held. Because the vesting of restricted

stock triggers an early tax liability, a sale of 40% of stock

to pay the tax usually follows.

On the other hand, the tax on employee options can be

delayed until expiration day, perhaps 10 years from the

grant day. There is no income tax liability when the

options vest. This factor makes stock options more

attractive to the employee.

4.The tax deduction to the employer is enjoyed sooner with

restricted stock (i.e. at the vesting). This factor makes

restricted stock more appealing to the employer because the

employer wants early tax deductions. 

5. The common stock is always more valuable than the

employee stock options to buy the common stock. The

stock could be as much as 2 to 5 times as valuable as the 

employee stock options on grant day, depending mainly on 

the assumed volatility of the stock and the time remaining

to expiration.

Therefore, employers will grant far less shares of restricted

stock than employee stock options to purchase the same

number of shares, if the object is to make an equally valued

grant.  

In order for the employer to grant restricted stock equivalent

to the Fair Value of employee stock options, a theoretical

value calculation of the options is required.

The employer then determines how many shares of

restricted stock equals the theoretical value of the ESOs 

that would have otherwise been granted.

6. Granting restricted stock is far more simple than granting

employee stock options. The value of the stock is certain

for the employee and the employer (at least those that are

traded daily). Simplicity helps the employer and the employee.

7.There is never the concern for the proper management

techniques of restricted stock as there is for employee stock

options.

Employees can manage the employee stock options to get

more value than what the employer anticipates to be the

options Fair Value. There is no such opportunity for the

employee with restricted stock.

8. Employee stock options generally result in an alignment

of the interests of the employer with the interests of the

employee for a longer period of time, since restricted stock

can be sold immediately after vesting. Early exercising

employee stock options forfeits value back to the company

and an early tax liability.

This gives informed employees holding options 

an incentive to hold the options longer and and stay at the

company longer. Employee stock options, in this regard,

work in the favor of both the employer and the employee.

8. The employer, when granting employee stock options, 

is now faced with calculating the theoretical value of the

options on grant day and expensing that value over 

the vesting period. This of course works as a negative

for the employer which grants employee stock options, if

the employer reports GAAP earnings.This consideration of

expensing "fair value"  is what is encouraging employers

to switch all or part of their equity compensation to

restricted stock.

9. Restricted stock is certainly a more stable asset than

employee stock options. Options values change for so many

reasons. The time premium erodes over time. The theoretical

values of the ESOs decrease as volatility goes down . ESOs

decrease as interest rates decrease and as dividends

increase. But when the stock flies on the upside, ESOs 

explode with a "bang not a whimper".

John Olagues    olagues@hotmail.com

P.S. Executives and employees should seek from the employer

a mix of employee options and restricted stock rather than all of

one or the other.

Check out my latest webcast

http://www.brighttalk.com/webcasts/8004/attend