Google Transferable Employee Stock Options

Google has introduced another financial innovation in relation to its own stock by allowing its employee stock options to be transferred after they have vested. Details on the transferable stock options (TSO) are available on its blog and several links in that blog entry. Google says:

When the options are sold to a bidder under the TSO program, three changes occur:

1. The remaining life is shortened to two years unless the remaining life is less than two years. If the remaining life is less than two years, then the transferable life is further reduced from two years in six-month increments (e.g., 18 months, 12 months, six months) until the remaining transferable life is zero. For example, an option with a remaining life of 23 months will, upon sale in the TSO program, have an 18-month life.
2. The forfeiture provisions related to the employee's employment with Google are removed.
3. We anticipate the anti-dilution provisions will be changed to conform to market-standard provisions.

Some conclusions are obvious. Any employee who is leaving Google should sell all long maturity options since that allows them to realize at least the value of two year options. If they do not sell, they would have to exercise the options within three months of quitting so as to avoid forfeiting the options. Employees should also sell options that have residual maturity of around two years or less to diversify their portfolios. They should ideally sell the options on dates when the residual life of the options is a few days more than an integral multiple of six months.

The hard part is those who do not intend to leave Google soon and who have options with much more than two years to maturity. Finance theory would suggest that they are better off delta hedging those options rather than shortening the lives of the options. If they are really sure that they will stay with Google for a long time they might also want to hedge the gamma and vega of their stock options with exchange traded options. But in practice, shorting stocks is not very easy for individuals and many might choose to sell the options rather than hold on to them. Probably, only the most financially sophisticated employees will hold on to the options and most others will sell. Incidentally, the possibly most sophisticated employees (the executive management group) is excluded from TSOs altogether.

All in all, Google has added value to its stock option programme and created a model that many other companies will try to emulate. There is an accounting charge as the existence of the TSO increases the expected life of the employee stock options and therefore their fair value. But this is I think a small price to pay for the added benefits. Perhaps, this effect might also be offset by issuing less number of options.

The most interesting question is whether this can be done with unlisted companies. I am sure some hedge funds would be quite willing to bid for even these options if there is reasonable assurance of a liquidity event in the not too distant future. That would add a lot of value to the employees.

Posted at 1:25 pm IST on Wed, 13 Dec 2006         permanent link

Categories: accounting, corporate governance, derivatives

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