March - 2000 - issue > Cover

Traditionally most of the compensation packages include a salary and other benefits such as medical, 401(K), employee stock purchase plan (ESPP), vacation etc. Some consulting positions include compensation for working over time and others might have performance-related bonuses. Most of these benefits are tangible and often easy to compare, accounting for other factors such as cost of living and taxes. However, it is becoming increasingly popular to offer stock options, which were once limited to senior executives, to employees at all levels to attract the best of the talent. This appears to have become a standard practice especially in the technology sector. This adds a new element in evaluating new job offers when planning career moves.
For those not familiar with stock options, let me start by explaining in simple terms what these are and how they work. Stock option grants are designed to insure that the employee makes a continued contribution to the growth of the company, and also to insure that the employee benefits directly as the company itself grows. The stock options, however small they may be, give a sense of ownership to the employee.

The options have what is called a vesting period, a time frame over which the employee will become eligible to actually own the stock. To take an example, say, company ABC can offer an employee a grant of 2,000 options over a vesting period of four years, with one-eighth of the total options vesting every six months. If the exercise price of the options grant was to be determined by the lowest closing stock price of the first and last days during the financial quarter that the employee joined the company.

In such a situation, assuming that the stock closed at $25 on the first trading day of the relevant quarter and at $32 on the last trading day of the relevant quarter, the fixed price at which the option could be exercised is $25. What it means is this: the employee will gain the option to buy 250 shares of ABC common stock at a price of $25 every six months during the next four years of employment. So after one year of employment, if the stock were to rise to $52 the employee would stand to gain $13,500, should he or she exercise the option.

Policies governing the vesting schedule, determination of the exercise price for the stock options, how the vesting will be affected in the event of extraordinary leave periods of long duration and such other issues tend to vary from company to company. Do the policies governing stock option grants really matter?

To a certain extent they do. For example, two option plans with the same vesting period of four years might have different vesting schedules. One plan might enable you to vest one-eighth of the total grant every six months whereas the other plan might offer to vest 50 percent after every two years. Though one can reap the full benefit of the option grant by working with the company for the duration of four years in either case, the former offers a better vesting schedule because, if for some reason an employee were to leave the company after 18 months, he or she would have some options vested under the first plan but none under the second plan.

Also, a plan where the exercise price for the stock option is determined by the closing price on the day prior to the day of joining of the employee is less flexible compared to the one that takes into account the stock price on two different days of the quarter in which the employee joins.

These may not be deciding factors but, from the employee’s point of view, definitely good to know and understand. The specifics of a stock option plan can usually be obtained from the human resources department of the prospective employer.

To continue with the example of the ABC Corporation, let us assume that an employee also received a job offer from XYZ Corporation. While evaluating factors such as job title, work description, prospects etc. the employee is also faced with the difficult task of comparing the compensation packages. Whereas it is fairly easy to compare monetary benefits it is more difficult to evaluate stock option grants. How can one compare 2,000 stock options of ABC with 4,000 stock options of XYZ?

There is no definitive answer that I know of. One way to compare the two is to make a common basis, which is the investment capital. Assuming that the stock prices of both ABC and XYZ are going to appreciate by the same percentage points over a period of time, the more the investment capital the more the benefits to the employee. To arrive at the investment capital for the respective companies, you could simply multiply the number of options by the stock price.

Another implicit assumption here is that the stock prices of both companies will be affected by the same percentage points when the grant prices are determined following acceptance of employment.

In reality, the actual benefit would depend on how well the stock performs and nobody knows about the future performance of an individual stock or market index. But if you assume equal prospects for both the companies or want to compare the two companies’ stocks based on present-day valuations, then what we discussed so far is just one way to make a common basis for comparison.

One other way to compare the two stock options is to compare the cost of acquiring similar rights to exercise at a predetermined price from the stock market. Getting back to the previous example, an employee would vest 500 options of ABC compared with 1,000 options of XYZ assuming that both plans offer a vesting schedule of 1/4th of the grant every year.

There are mathematical models that can determine the costs of acquiring the same rights in the stock market. The most popular among them is the Black-Scholes model, which computes the theoretical price of an option based on the stock’s current price, the strike price, time till expiration, volatility of the stock and several other factors. However, one can find market prices for each contract (one contract is equal to 100 options on the common stock) for one year for a strike price close to the price at which the stock is currently trading. Not all the stocks are optionable but for those for which options are listed, the prices can be found at sites such as and .

For the sake of greater clarity, let me illustrate examples with some real-world names such as IBM and Yahoo. As of close of business on Jan. 21, a one-year contract, consisting of 100 options of IBM shares with a strike price of 120, was quoted at about $21 per option. What it means is this: it would cost $10,500 to acquire the right to own 500 shares of IBM at $120 per share any time before Jan. 19, 2001.

On the other hand, a one-year contract of Yahoo! stock, with a strike price of $350, was quoted at $100 per option. Therefore, it would cost $50,000 to acquire the right to own 500 shares of Yahoo! stock at $350.00 any time before Jan. 19, 2001.

Comparing the face value of the option grants based on these long-term equity anticipation securities, or LEAPS, is beyond the scope of this article. But on the face of it, we can say that LEAPS may not be a better basis of comparison than investment capital, which we discussed before. It is worth noting that it might require thrice the investment capital for the same number of options compared to the multiple of five times if you compare using LEAPS. One reason for the difference: LEAPS also factors in stock price volatility, indicating a high risk/high reward scenario.

Now that you get the picture, you could do your math. The point of this exercise is to form a basis for comparing different stock option grants, and to formulate guidelines to for further analyses. I like to reiterate the fact that how much, in reality, one stands to gain over a period of time depends solely on how well the particular company’s stock does during that period. In this regard one should do some research on the fundamentals of the company and its growth prospects. It may also help to talk to current employees to and find out how they view future prospects and even take expert opinion before making the decision.

Having said that, finally it still comes down to one’s ability to foresee the future, though one need not make a blindfolded decision.

In the case of a company that has not gone public yet, it is even more difficult to evaluate stock options. These present a high risk/reward. Often, these startups, funded by venture capitalists, try to acquire talent with attractive stock option grants, often combined with salaries that are lower when compared with the industry’s average levels.

You may have heard of several individuals who reaped great rewards by betting their future on such startups. At the same time, it may be worth noting that there are many with boatload of vested options that are less valuable or even worthless. Often, such a situation arises not because the individual performed badly, but because the firm performed poorly overall.

Now you may want to wonder if intelligence and hard work alone can guarantee success!