Recent research conducted by faculty at the University of Illinois and Michigan State University finds that, on average, executives value their stock option holdings at 40% of the opportunity cost to the company. More important, however, is their finding that this “cost-value” gap can be closed by employing a short but effective personalized equity education program.
Net Worth Strategies, Inc. has repeatedly conducted studies at the National Association of Stock Plan Professionals Conferences and discovered that experts in equity compensation also underestimate the value of equity compensation holdings even though they understand valuation models and the leverage inherent in stock options. (Net Worth Strategies offers corporate education programs, a family of equity compensation planning software and advisor support services.)
Bill Dillhoefer, Vice President of Net Worth Strategies, addresses the cost-value gap in a white paper aimed at helping CFOs and CEOs maximize the effectiveness of their equity compensation programs. Dillhoefer believes that companies have a responsibility to take action to close this cost-value gap and should invest in a brief education program to bring the value more in line with the cost.
According to Dilhoefer, the payoff from personalized equity compensation education comes from the following three areas:
- Improved retention of key personnel. As all corporate officers know, the cost and pain of losing even one of your best and brightest can be staggering. If key people have embraced the full value of their holdings, outside recruitment discussions are likely to be short lived.
- Increased
motivation of key personnel and alignment with corporate objectives. Executives who understand and have embraced the upside potential of their holdings, and the importance to their financial goals, are more likely to dedicate themselves to driving earnings and avoiding actions that might jeopardize the stock price.
- Responsibilityto owners for the full value from their investment in equity compensation. As a result of accounting scandals and new regulations, shareholders and groups that represent them have placed a spotlight on the dilution and income statement impact of equity compensation programs. To date, the focus has been on the cost side of the equation. As shareholders come to understand the cost-value gap, however, they are likely to focus on the value side as well -- particularly since the cost to close the gap is relatively small.
Because companies must book and expense options based on Black-Scholes or another approved valuation method, the existence of a “cost-value gap” raises important questions regarding the viability and effectiveness of stock option programs in fulfilling their stated purpose of motivating and retaining key employees.
In light of mandatory option expensing and increased shareholder scrutiny, a little more education will go a long way to ensuring that your employees realize the full value of their equity compensation. Read the white paper here.