March 15, 2017
Are Options Making a Comeback?
– Broc Romanek
Here’s an excerpt from this interview with Meridian Partner Bob Romancheck:
What catalysts exist today, including the results of the presidential election, that could trigger a reemergence of the use of stock options?
There are multiple catalysts now in place that could prompt an increase in the use of stock options. The single strongest factor is the recently created expectation of economic growth. The articulated policies of President Trump have caused the stock market to jump in anticipation of a much stronger rate of US economic growth than we have seen for years. Recall that from the historic barometer, economic growth means some compensation committees may return to the use of stock options to incent further share price growth and to capture this upside (which is leveraged around 3 or 4 to 1, since economically, it typically requires the grant of three or four stock options to equate to the grant value of one restricted share or performance share—so potential upside is significantly higher with the use of stock options).
Additional catalysts include the much lower dilution rates that now exist across US public companies (making room for option grants). Also, the initial shock of requiring an accounting expense for stock options has long since worn off. The accounting cost is now mostly neutralized, since all types of long-term incentive vehicles require an expense charge of about the same magnitude (note, although the Black-Scholes expense for a stock option, in simple terms, may be approximately one-third of the grant price, since it often takes three times as many NQSOs to equal the grant value of restricted shares, the expense comes out about the same).
Finally, there is still the benefit of a corporate income tax expense and possible cash inflow for the company at exercise. And stock options have always been a great income tax deferral mechanism for executives, although tax deferrals may not be quite as valuable in the future, with the likelihood of lower marginal income tax rates.