Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

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.

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