Risk Management

Why Employers Should Sound the Alarm on Expiring Options

Bad communication can send the wrong message.
David KatzJune 28, 2001

How interested are employers in alerting employees that their in-the- money stock options will soon expire?

Listen to Tim Clancey and you might get the idea that employers simply aren’t that concerned.

In May 2000, Clancey, now a vice president at a bank in Northern California, left a similar post at another bank in the region. (He did not want to reveal the name of either bank). On December 15, 1999, his former employer granted him the option to buy 500 shares of its stock at $16 a share.

December 15 was “the most important date I’d been fixating on,” since on that particular date the bank had agreed to vest him in options for 500 shares each year for 10 years, starting in 1997—so long as he stayed with the bank, Clancey tells CFO.com.

So when he left the company in May, Clancey thought he had until December to exercise his options for that year. Nothing that was said in his two-minute exit interview or written in the signed exit documents suggested otherwise to him.

But Clancey hadn’t absorbed a certain detail he assumes was buried somewhere in the voluminous plan document he’d been issued when the benefit began. “Unbeknownst to me, my options expired 60 days after I left the company,” the banker says.

He just learned of the fact in August 2000, when a friend told him that was the most likely scenario, since many option plans carry expiration dates 60 or 90 days after an employee leaves the company. When Clancey’s options expired, the shares were worth $24 each, meaning that had he cashed in his chips before that date, he’d have been $4,000 richer.

While that isn’t a great deal of money, a big company with a sizable option program could save itself a nice amount by communicating as little as possible about expiration dates.

To be sure, it’s true that employers who issue nonqualified stock options get a tax deduction equal to the ordinary income tax that employees must pay on the spread when they exercise in-the-money options.

Despite that tax break, however, it’s in the employers’ immediate financial interest to sit back and do nothing as their employees let their options expire unexercised, says Corey Rosen, executive director of the National Center for Employee Ownership (NCEO), a private nonprofit research organization based in Oakland, Calif.

Contrary to a popular belief, providing options to employees is “not free at all” to employers, notes Rosen. “It’s precisely the view that they have a real cost” that moves the Internal Revenue Service to provide employers with a tax benefit for enabling employees to buy stock at below-market rates, he adds. The increased float then mathematically lowers earnings per share.

Even so, only the most unscrupulous employer would hatch a plot to keep expiration dates quiet in order to save money or deprive a hated employee of a benefit, says Rosen.

“Only the most corrupt corporate mind would come to that conclusion,” he adds.

To be fair to Clancey’s former employer, however, corruption didn’t have to be at the bottom of the bank’s motivation. Clancey, after all, left the company on his own steam. What incentive did the bank have to communicate more than was legally necessary?

One motivation could have been to avoid public criticism by the likes of Clancey. In any event, he hasn’t identified the bank to the press.

The incentive to telling existing employees that their options are about to expire worthless, however, seems much stronger. That’s because a prime goal of issuing options is to tie the fate of existing employees to that of the company and thereby improve overall performance.

Yet even here, many employers seem to be falling short in educating option holders. According to a study released by OppenheimerFunds last August, 11 percent of 307 holders of employee stock options had allowed in-the-money options to expire worthless.

Another recent manifestation of poor employer communication in the current down market could be seen in the news reports of employee option holders unexpectedly smacked by the double whammy of depressed share prices and huge alternative-minimum-tax payments.

The reason for such weak communication may be a poorly conceived strategy. Clancey says, for instance, that his former employer offered options because it was a way “to keep management happy.”

That suggests an approach of offering options merely for show–a wasteful and a risky strategy, especially if employees end up feeling hoodwinked and the company’s image suffers as a result.

“A mistake would be to make [an option grant] an award, so that employees just see it as a gift,” as if employees had won the lottery or a “corporate crapshoot,” says Bruce Finley, the head of human resources communications for William M. Mercer Inc., in New York.

That would squander the value of what many still regard as a powerful tool for improving corporate performance. Done effectively, a broad-based option plan, for instance, can get employees “to understand how a business works and [make] that business more successful,” Finley says.

Finley and other consultants are developing online communication tools for clients that show employees in detail how much wealth their options are accumulating and explain other details of the plans. In fact, he and his colleagues are talking about placing such option communications online for both Mercer and Marsh Inc., both subsidiaries of Marsh & McLennan Cos.

Despite such innovations, experts say, the “infrastructure” of communicating stock options lags behind that of communicating the details about 401(k) plans, which have been on the employee-benefit scene much longer. But they expect the gap to close fast.

For some employers, however, making their options work effectively seems more a matter of corporate will than of technology. That means overcoming the impulse to keep mum about expiring options and telling employees clearly how much time they have before they must buy.

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