This article advises employee/executives on what

they should try to accomplish when negotiating with

the employer over a equity compensation package.

Most executives and managers, even of the largest

companies, do not understand the nature of, the

value of, or the proper management of employee

stock options. They generally rely on a valuation firm

that makes theoretical calculations as to the value

of those ESOs.

They rely on compensation consultants to advise on

the type and terms of the Options and Stock

compensation plans. The executives hire consultants

to help them personally get the best deal from the company.

Lower level employees generally, just accept what is offered.

Many executives and employees claim that the options

are far less valuable to themselves than what FASB

{Financial Accounting Standards Board} requires the

companies to calculate and expense. This is the case with

Cisco, which made an attempt to artificially lower the

valuation by setting up a "market based" analysis of

the ESOs values. What is the answer?

Some general principles to follow in negotiating:

A.Try to have equity compensation paid in the

form of a balanced portion of Employee Stock

Options and Restricted Stock.

For example:

Assume that the theoretical value of options to buy

3000 shares, considering all measurable factors, 

equals the theoretical value of 1000 shares of 

Restricted Stock.

Under that assumption, the value of a combination

of options to buy 3000 shares plus 1000 shares

of restricted stock equals the value of options to

buy 6000 shares. However, in general, the combination

of options to buy 3000 shares plus the 1000 restricted

stock should be preferred by the executive/employee

over the options to buy 6000 shares.

The combination, in general, should be preferred by the

executive/ employee over receiving just the 2000 shares

of restricted stock. Why is it better to have 3000

Options + 1000 shares than 6000 options or 2000

restricted stock?

First, go to the article Stock Options V. Restricted

Stock on this site for a good comparison of the

two forms of equity compensation.  There are several

reasons why we choose the combination rather than

"all Options" or "all Restricted Stock".

1. The combination is less risky than "all Options".

2. The combination offers more potential gain than

"all Restricted Stock".

3. The combination is more tax friendly after vesting

than "all Restricted stock".

The combination is even more tax friendly when

managing the ESOs plus restricited stock.  Exactly

why it is true that the combination is more tax 

friendly to managing the equity compensation is

beyond the scope of this article. Essentially it has

to do with the ability to sell listed options using the

formerly restricted stock as collateral and the fact that

when formerly restricted stock is sold, there is no

time premium forfeited.

4. The combination is more friendly to reducing

risk by hedging with or without selling listed calls.

The explanation for this is also beyond the

scope of this article.

5.The employee will end up with more money if he

properly manages the combination  than if he

properly manages "just Options" or "just Restriced

stock" of equal value.

B. Try to get the employer to reduce the

restrictions on hedging with listed options

to as little as possible.

This actually puts more value in your options 

and allows for possibilities of sufficient risk reduction

from holding both the options and the stock .

C. Request that at least some of your options

to be Incentive options.

This allows the prospect of long term capital gain

rather than ordinary gain on your incentive options.

 D. If you anticipate that your term of employement

will be short  (i.e. less than four years) try to get as

much restricted stock as possibleand avoid

options altogether.

E. If you are confident your employement will last

over 8 more years,you should try to have at least a

65/ 35 ratio of options value/

restricted stock value. Perhaps a good mix is

options to buy 5000 shares for every 1000 shares

of Restricted Stock. 

F. Of course if the employer is valuing the options

far greater than they should be valued in order to

influence the employee/executive to accept more

options, then you should try to avoid accepting stock

options at all and choose restricted stock.

G. The same is true for the employer who is

understating the value of the options in negotiations.

Try to put a greater weight on receiving ESOs in that case.

Through out the negotiations the executive needs

 an advisor who knows "theoretical value" calculations. 

That person must also know what impact the specifics

of the Options Plan has on the value of the

options and the ability of the executive to manage his

equity compensation.

This is not a simple matter.

John Olagues

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