.

How much does Equity Compensation Grants Cost the company?

Example 1:Assume that 100,000 shares of restricted stock are granted to one of five top executive where the current stock price is $50.00. The RS has a 1 year vesting depnding on the employement beyong the one year. No other performance required.

After 1 year, the stock is $55 and sold by executive to pay taxes and for other reasons. The alignment ends after one year.The cost to the company is $5,500,000, which is not tax deductible making the after tax cost $5,500,000.The theoretical cost may have been near $5,000,000 at grant for 1 year of alignment.

.

Example 2:Assume that 500,000 Employee Stock Options are granted with an exercise price of $50, vesting and expiration after one year.

After 1 year, the stock is $55 . The ESOs are exercised and the stock sold to pay taxes and for other reasons. The alignment ends after 1 year.

The actual cost to the company is $2,500,000 and is tax deductible, making the after tax cost in California $2,500,000 x .57 = $1,425,000The theoretical costs at grant with a volatility of .30 and no dividend was about $3,000,000 for the 1 year of alignment.

.

Example 3:Assume that the restricted stock and the ESOs had 3 year vesting with the expiration of the ESOs 3 years from the grant. These are the only changes from Examples 2 and 3.

The actual costs would be the same as in Examples 1 and 2 but the aligment would be for 3 years instead of just 1 year.

The theoretical values at grant would be about the same for the Restricted Stock but for the ESOs, the theoretical value would be about $5,300,000, instead of $3,000,000.In this Example 3, the costs per year of alignment to the company can be determined by merely dividing the 3 year alignment costs by 3.

.

Costs per year of alignment is $5,500,000/3 for Restricted Stock = $1,833,333Costs per year of alignment is $2,500,000/3 for ESOs = $833,333.

After tax alignment cost per year for top executive for Restricted Stock equals $1,833,333

After tax alignment costs per year for top exercutives for ESOs equals$833,333 x .57 = $474,999

.

If we assume that the stock was $70 instead of $55 after 3 years.

The after tax costs per year alignment for the restricted stock is

$7,000,000/3 = $2,333,333.

The after tax costs per year alignment for the ESOs would be $12,500,000 x. 57 = $ 7,125,000/3 = $2,375,000.

.

If we assume that the ESOs expired in 6 years and the ESOs were held for 6 years, and the stock was $70 after 6 years, the costs to the company per year for the ESOs would be divided by 6. And the $7,125,000 would be divided by 6 to determine the per year cost.

The per year after tax cost of alignment for ESOs would be $7,125,000/6 = $1,1875,000

.

So what conclusion can be drawn for the above 6 slides.

The answer is that the annual after tax costs to the company of granting ESOs to top executives is far less that the costs of granting RS, even when the volatility is reasonably and 5 times more ESOs are granted. This is true even when the stock is 40% higher than the grant price after 6 years.

There is about a 37% chance that the stock will be above $70.00 on the six year expiration day.So why would companies make Restricted stock grants instead of ESO grants to top executives when the after tax costs are so much higher.John Olagues504-875-4825olagues@gmail.com www.truthinoptions.net