CEO's and Stock Options--Simple Explanation Here

• Footwedge

  For anyone that cares....but is a little in the dark on how stock options pay to an exclusive club....here's is a simple example on how it works. Not everyone works on Wall Street and are in the financial sector. Some financier gurus lay claim that these are indeed quite fair...well you other guys can make the call.
  
  Of the countries' top 500 CEO's, the pay range is somewhere between 2 million per year and 80 million per year. I'm going by memory, and as such, the range might indeed be higher.
  
  But let's say Joe Crackerjack is the CEO at Special Widget Enterprises and his compensation is 10 million dollars. Mr Crackerjack has accepted this package...but his pay is divided into 2 separate classes.
  
  He will be paid $200,000 in cash.....and he will be paid 9.8 million in company shares from his own corporation, Special Widget Enterprises.
  
  When the exec signs his contract for the year, the stock may be trading at $125 per share. As such, the contract that he signs states that he will receive 78,400 shares at the end of the year in compensation. (9.8 million divided by 125 dollars per share).
  
  The CEO sympathizers will state that his income is at high risk....and as such, he/she should be entitled to pay less in taxes.
  
  So how does he/she in fact pay less taxes?
  
  Today, the top marginal federal tax bracket is around 38%. If Mr. Crackerjack received all of his pay in cash, then he would pay, $3.8 million in Federal tax.
  
  In the example I showed above...which is the norm for the high end Wall Streeters, Mr. Crackerjack would pay the following in Federal tax.
  
  $76000 (200K x 38%) plus
  1.47 million (9.8 million x the capital gains rate of 15%)....for a total tax of 1.546,000.
  
  In essence...the EXEC has skirted his tax responsibility by.....
  
  3.8 million less 1.546 million==2.254 million dollars.**
  
  ** Note that these numbers would be accurate if the company stock's trading value is exactly the same (125/share) at the end of the year.
  
  Is it fair that the 10 million dollar man pays 16% and the 200K/per year salesperson has to pay 38%?
  
  Now in real life, the corporation's selling price per share over any given year, the stock price will inevitably change.
  
  Let's look at 2 extremes and compare...
  
  Let's say that special widget Enterprise's stock had a bad year and lost a whopping 40% in value and as a result, the CEO's stock was now trading at 75 per share.
  
  His total pay for the year would be as follows.....
  5.88 million (78400 shares x 75 per share) plus
  200,000 in cash==
  
  6.080 million....of which his tax liability would be 76,000 (38% x 200K) plus 880,000 (5.88 x 15%) for a total tax bill of $960,000...which in essence is again 16%.
  
  But there's more!. These reduced taxes are only realized if the CEO sells his stock at the end of the year. If not, he will pay ZERO federal tax...until he actually sells the "capital" that he was paid.
  
  Most execs will not sell their stock...but instead reinvest into their own private account....and defer all taxes until actually sold years down the road....very similar to how a typical IRA is funded...accumulating wealth, while deferring or postponing any tax payments.
• Manhattan Buckeye

  "As such, the contract that he signs states that he will receive 78,400 shares at the end of the year in compensation."
  
  That isn't a stock option.
• Manhattan Buckeye

  ^^^
  
  The contract doesn't even exist, Footwedge doesn't understand options, it is an option to purchase stock at a certain price, not an option to take comp in the form of stock.
  
  Uitilizing the hypo, in reality if Joe Crackerjack signs his option agreement, assume the strike price would be $125 (and often it will be higher, but that's another discussion).
  
  If the stock price falls to $75, that element of compensation is worthless. No one will spend $125/share for stock worth $75/share, if they wish to be long on the stock they can buy on the open market.
  
  Taxes don't even enter into the equation.
• Belly35

  

  Stock options or entitlments
  I support the Stock Option guy ..he's got grit the other guy just quit
• Con_Alma

  WTF That's not a stock option!!!!
• queencitybuckeye

  Veracity is not exactly the OP's long suit.
• fan_from_texas

  This is an amazing thread.
• sjmvsfscs08

  hahahahahahahahahahahahhahahaahaa
  
  
  This may be the biggest fail in the history of the internetz.
• Mr. 300

  

  sjmvsfscs08;439241 wrote:hahahahahahahahahahahahhahahaahaa
  
  
  This may be the biggest fail in the history of the internetz.

  
  Not to worry though, he's had plenty of them over the years.
• iclfan2

  

  
• general94

  This whole topic is pointless. I admit, I don't know that much about stock options and doubt if I ever will need to know much about them. As long as we have our present tax code, people will find the way to pay as little tax as possible, and more power to them. Do away with the IRS and a flat tax of 10% on any income, or a national sales tax that is the way it should be. If 10% is good enough for the Good Lord, then it is good enough for Uncle Sam.
• Writerbuckeye

  

  Mr. 300;439332 wrote:Not to worry though, he's had plenty of them over the years.

  
  And will likely have plenty more.
• jmog

  Footie couldn't be more wrong if he had lied on purpose.
• queencitybuckeye

  jmog;439652 wrote:Footie couldn't be more wrong if he had lied on purpose.

  
  Can one lie accidentally?
• jmog

  queencitybuckeye;439657 wrote:Can one lie accidentally?

  
  Sure.
• Manhattan Buckeye

  "It's not a lie if you believe it."
  
  -George Costanza
• majorspark

  

  queencitybuckeye;439657 wrote:Can one lie accidentally?

  
  People can post things falsely believing them to be true and post it. It would only be a lie if he truly believed he was posting something that he believed to be untrue. If that is the case and he was innocently wrong he should be man enough to admit it. Or defend himself. His absence since his OP could be telling.
• Footwedge

  majorspark;439690 wrote:People can post things falsely believing them to be true and post it. It would only be a lie if he truly believed he was posting something that he believed to be untrue. If that is the case and he was innocently wrong he should be man enough to admit it. Or defend himself. His absence since his OP could be telling.

  I admit that my OP example is erroneous in the overall content. For all the circle jerkers here, pound your puds in bliss... With that said, CEO stock options are applied somewhat differently than generic stock options.
  
  from Wiki....
  
  Employee stock options (ESOs) are non-standardized calls that are issued as a private contract between the employer and employee. Over the course of employment, a company generally issues vested ESOs to an employee which can be exercised at a particular price, generally the company's current stock price. Depending on the vesting schedule and the maturity of the options, the employee may elect to exercise the options at some point, obligating the company to sell the employee its stock at whatever stock price was used as the exercise price At that point, the employee may either sell the stock, or hold on to it in the hope of further price appreciation or hedge the stock position with listed calls and puts. The employee may also hedge the employee stock options with exchange traded calls and puts prior to exercise and avoid forfeiture of a major part of the options value back to the company thereby reducing risks and delaying taxes.
  
  So....whereby my OP is certainly in error as written, it's pretty clear that CEO stock options entail the company being forced to sell the stock to the employee. As for Employee Stock Options being a legal tax loophole, which allows CEO's to both reduce 60% of their tax liability on income via this vehicle, or defer income tax altogether by holding...I don't digress. I've posted numerous links supporting the position that employee stock options as loopholes for CEO's.
• Footwedge

  Oh...and one more thing. Many CEO's are in fact compensated with company stock...which is vested over a certain period of time. This is a tax deferred vehicle as well...and when sold....circumvents the federal income tax rate. Had I used the term "stock"...as opposed to "stock options", then my OP example would be an accurate assessment.
• LJ

  

  I love when people have strong opinions on things they don't understand. Oh and many people are compensated in stock, not just the evil ceos and not just for circumventing taxes. People are compensated in stock because it is an incentive to do your job well to help your company you work for become more profitable and it is also used for cash strapped start ups when cash compensation for high qualify talent isn't an option (stocks don't have to be publicly traded in order to be compensated with it)
• Writerbuckeye

  

  You lost him LJ. He comes from a school of thought that believes people have a RIGHT to certain things, whether they work hard or not. And if they work too hard and well, they damn well should be ashamed of themselves and give all their earnings to the government for those who don't (or won't) work as hard.
• queencitybuckeye

  Footwedge;439722 wrote:I admit that my OP example is erroneous in the overall content. .

  
  IOW, you lied.
• sjmvsfscs08

  I remember when First Solar was starting in Perrysburg and they gave out the evil STOCK OPTIONS to their employees in their factories. Plenty of people who dropped out of college or simply didn't go were made millionaires when the stock was given to them at $20 and skyrockets up to like $180 or something silly. They went evil and recalcitrant CEOs, they were everyday guys who hit the jackpot.
• Manhattan Buckeye

  " People are compensated in stock because it is an incentive to do your job well to help your company you work for become more profitable and it is also used for cash strapped start ups when cash compensation for high qualify talent isn't an option"
  
  And more importantly, shareholders often prefer employees are compensated in options (even though it results in dilution) if the company's cash flow is still growing.
  
  At any rate, the only links I saw Footwedge post was the one that had nothing to do with tax liability on the recipient end and the wiki piece above. This is actually a fairly well written article for the layman:
  
  http://www.mbbp.com/resources/tax/restricted_stock.html
  
  Whether it is an NQO, ISO, or restricted stock (which I assume Footwedge is referring to above), as the article explains the recipient isn't escaping the taxman. The only potential preferable tax treatment is with an ISO, but you have to abide by more stringent holding rules than you would if you simply bought the stock on the open market, all other ISO treatment conditions need to be met, and even then if you are in AMT land you still may have a tax liability on exercise - which happened to us.
  
  I've never worked at a company that compensated employees in this manner, but my wife has and exercised twice (she had ISO's), the first time I didn't know she did as we just got married that year and had not got around to synching our accounts. We were in AMT land and I didn't report the exercise since I didn't know about it - and she wanted to hold the stock, so when I got a letter from the IRS a few months after filing I had to learn quickly how ISO's work with the AMT, and it was a major PITA.
  
  She exercised again what few "in the money" options she had when we moved out of NY because as an ISO, she had a limited window to exercise, we did an exercise and sell with her broker and I can assure Footwedge or anyone else we paid ordinary income on the gain. The ISO treatment was worthless to us.
  
  All of this for probably an overall gain of $2,000 (for both exercises).
• queencitybuckeye

  Manhattan Buckeye;440003 wrote:All of this for probably an overall gain of $2,000 (for both exercises).

  
  $2,000? You rich bastards are the reason the middle class is disappearing.