… back during the “dotcom” boom and bust the way companies “expensed” stock options became an issue
This was actually one of “case studies” when I was doing the MBA thing. The details are something that accountants might find interesting – e.g. the big picture question was if “back dating stock options to retain employees” was “ethical” or not — I think it was one of those 10,000 words assignments – short answer “of course it is not” 😉
huh? what?
First some quick definitions — Story time!
Ok, imagine that someone starts a business. Then assume that the company is growing and decides to seek “outside investors.”
The company has two basic options – they can take out a lone OR they can sell partial ownership of the company.
A loan comes with the obligation to pay it back plus interest. When the loan is treated as an investment it gets called a “bond” -it is a binding legal contract.
Selling partial ownership sounds simple – but quickly gets complicated.
Imagine a group of four friends starts a company. If each person owns a equal part of the company we could say that the company “stock” consists of four “shares.”
Well, with just four people the arrangement would probably get called a partnership. The problem with a simple partnership is if something goes wrong ALL of the partners will be held responsible.
Now if you are starting a business with people you know and trust you might be willing to take that risk. BUT then when the company needs to seek “additional investment money” and more “partners” are added – the risk of one partner ruining EVERYONE increases.
The way of dealing with the risk of partnerships is a “limited liability” business structure. “Investors” in a limited liability company might lose the money they have invested in that company – but the investors other assets are safe.
A “financial advisor” would call the idea that you shouldn’t put EVERYTHING into ANYTHING – “diversification“
No, I’m not in the business of giving financial advice. “Big picture” – Money isn’t evil – the LOVE of money causes all kinds of problems.
The idea being that if you LOVE money you can never have “enough” – and then you will probably be willing to do all kinds of
“not wise” things to get “more.”
“Greed” is never “good” simply because greed implies getting more by hurting someone else. Looking out for your best interest isn’t greed. Investing wisely isn’t greed.
“You can’t cheat an honest man …”
W.C. Fields
That pull quote is the title of a 1939 movie starring W.C. Fields – yes it is a comedy. Consider the quote as a truism – if you can’t cheat an “honest man” then it is because an “honest” man isn’t looking to get something for nothing. SO you might be able to rob or steal from an honest man – but to “cheat” them requires feeding their “greed”
Since I stumbled onto the subject –
- Don’t invest in anything you don’t understand
- Don’t expect something for nothing
- Don’t put all of your eggs into one basket
- Don’t believe the hype – FOMO is a great way to be cheated
Meanwhile – back at the ranch …
SO we have stocks and bonds – which are the bread and butter of “corporate finance.”
A company has an “Initial Public Offering” (IPO) to raise money. Then companies might issue stocks and bonds as part of normal “finance” operations – which isn’t important here, except to point out that what you see covered as “the stock market” is a “secondary market.”
A company raises capital money by selling shares – and then those shares can be bought and sold on various “secondary markets.”
To be listed and traded on those markets the company has to meet various requirements – the specific of which aren’t important. What IS important is what is implied about a stock by where it is being traded.
Google “NYSE vs Pink Sheets” and the AI overview might tell you:
“The New York Stock Exchange (NYSE) is a highly regulated, centralized national exchange for large, established companies, while the Pink Sheets (now known as the OTC Pink market) are a decentralized over-the-counter trading system for speculative, small, or distressed companies.”
Motivation? Options?
The financial derivatives markets are where other “financial instruments” based on stocks get traded. These tend to be where the “professional investors” hang out. When you hear those stock market reporters talking about “options” and “futures” – that is probably what they are talking about. You’ll jump to jump through some hoops if you want to buy and sell in those markets.
Again, that isn’t important at the moment …
Founders of a company will have a substantial number of shares when the company “goes public” (has their IPO).
e.g
- Google tells me Mark Zuckerberg had 534 million shares of Facebook when it went public in 2012.
- The founders of Google (Larry Page and Sergey Brin) each owned around 15% of the Google stock when it went public in 2004 (which was millions of shares).
- Steve Jobs owned 11% of Apple Computers (7.5 million shares) when it went public in 1980
The point here being that founders of a company always “cash out” a little during the IPO.
In the era of “venture capital” those early investors goal is probably “IPO cash out” – which is always a high risk and high reward proposition.
HOWEVER for “founders” the IPO “cash out” is obviously important but not THE MOST important element of founding the business.
Of course the money is important – but once they have all the money they will ever need it ceases to be prime motivator.
What DOES motivate those founders after an IPO? Well, probably the same things that motivated them BEFORE the IPO.
The folks that actually knew Steve Jobs would point out that he saw technology in general (and Apple computer in particular) as a force for positive change in the world.
The Google Boys were inspired by solving a problem – they didn’t set out to change the world, but did. The “history of the internet” could be divided into “before Google” and “after Google” …
Mark Zuckerberg had Steve Jobs and Bill Gates as “tech entrepreneur” roll models – so he comes across as being the most “monetary motivated” of my selection – he still has “problem solving” and “world changing” as motivators
fwiw: The book that served as “source material” for the “The Social Network” movie was titled “The Accidental Billionaires” (2009 Ben Mezrich) – the book was interesting – I still haven’t seen the movie …
Insider Trading
AFTER the IPO if “insiders” sell shares they have to report that sale within two to four business days – well, that is required by the Securities Exchange Commission in the U.S. – I’m guessing stock exchanges in other nations have similar requirements.
The intent of a large number of SEC regulations is to protect the integrity of the various stock markets. After all if the stock is trading in a public market – then “insiders” could easily manipulate the market to increase (or decrease) the public share price.
Which makes the timing of “founders” selling their shares actionable intelligence for savvy investors.
IT ALSO means that an insider even appearing to accidentally manipulate stock prices something the SEC is going to notice.
Employee Stock Options
Total “executive compensation” REALLY took off when companies started offering “stock options” as part of executive compensation.
The theory is that that the publicly traded stock price directly reflects the companies value/performance. Then if the stock price goes up the people running the company must have done something good. Makes sense – it absolutely isn’t true 100% of the time but it has become common practice
Explaining EMPLOYEE stock options is a two drink exercise – short form – when a company grants “stock options” to a employee those options probably have a fixed price and a vesting date –
e.g. imagine “bigwig ceo” gets “x” number of stock options at a “price” and can exercise those options after a “certain period” of employment time –
if those stock options were granted at $1 and the vesting time is 4 years – the employee can “exercise” the option at whatever price the company stock is trading after 4 years – SO if the stock price went UP the employee has a valuable asset BUT if the stock price went DOWN the options are worthless
Remember – the point of “stock options” is to align “employee motivation” with “company outcomes”
A reasonable person might think that working for the “best interest” of the company is always a given – but that is only part of the equation.
I like to point out that if an “executive” is doing their job well – then it is hard to pay them TOO MUCH. Just like if “executive” is treating the company like their personal piggy bank – then it is hard to fire them fast enough …
Steve Jobs was getting $1 a year as CEO of Apple from his return in 1997 to his 2011 resignation. Of course there is more to the story – he also accumulated 5.5 million shares of Apple stock as compensation – which he left to his wife when he died making her one of the wealthiest women in the world (over $11 billion).
Startup stock options
The “legend of Apple Computers” includes former Apple employees with stories of being offered the choice between “Apple stock” or “cash” – and they chose the cash.
These stories are (probably) not ALL true, but they are plausible. i.e. startups are ALWAYS short on “cash” but granting stock options is probably cheap and easy.
Of course if the startup fails the stock is worthless – and if the startup becomes “Apple” then those shares could have been worth $millions.
Part of the “Google” story involves the fact that they gave stock options to a lot of “ordinary” employees – e.g. when Google had their IPO they had ~2,300 employees and ~1,000 of those folks become $millionaires after the IPO
of course founders Larry Page and Sergey Brine had a lot more stock then those folks and become $multi-billionaires
I’m gonna guess that those “ordinary employees” – working in building maintenance and the company cafeteria – PROBABLY quit their jobs. Then the highly qualified folks Google hired after those folks quit probably got a stock ownership option.
i.e. the solution to the growing gap between “executive compensation” and “ordinary employee wages” could include “ownership” options. Obviously there is no “one size fits all” solution …
Then there is Elon Musk …
All this came to mind because of the Elon Musk hit-piece documentary that is trying to portray him as a stock manipulator – which is specious at best-
I’m not sure how many companies Mr Musk has started – but that is his “secret to success” – i.e. he is a “serial entrepreneur.”
He earned $22 million for selling Zip2 to Compaq back in 1999. Then another $180 million when eBay bought PayPal in 2002.
The Tesla story is “messy” – but he is a big part of it one way or another. The Tesla board of directors and shareholders wanted to keep him around – so they came up with a (potential) $trillion compensation package that is loaded with performance objectives over 10 years.
Is Mr Musk worth $trillion to Tesla? That isn’t really the issue – but if he manages to meet all of the performance then the answer will be “yes.”
How likely it is that he WILL meet all of the objectives? I have no idea. I’m only interested as an observer – so I wish him luck …