Question

What is a potential downside to granting executives stock and restricted

stock? (hint: think diversification)

Answer 1

Ans.

potential downside to granting executives stock and restrictedstock :-

Downside potential risk is an estimation of a security's potential to suffer a decline in value if the market conditions change, or the amount of loss that could be sustained as a result of the decline. Depending on the measure used, downside risk explains a worst case scenario for an investment or indicates how much the investor stands to lose.

Investors, traders and analysts use a variety of technical and fundamental metrics to estimate the likelihood that an investment's value will decline, including historical performance and standard deviation calculations. In general, many investments that have a greater potential for downside risk also have an increased potential for positive rewards. Investors often compare the potential risks associated with a particular investment to its possible rewards. Downside risk is in contrast to upside potential, which is the likelihood that a security's value will increase.

Companies have adopted ever more sophisticated equity compensation plans. Brought on in part by accounting rule changes that make the issuance of any kind of stock-based compensation an expense when they are granted, many companies have lightened up on stock options and turned to outright stock grants that must vest before the shares can be issued.

For employees, many of whom had just figured out their stock options, these grants have added a new layer of complexity. This article presents six questions I get all the time from clients who have received restricted stock, restricted stock units (RSUs), or performance shares.

This means that the stock won’t actually be paid to you until some future date. This also means that the future value of the stock is unknown, as with stock options. But unlike options, which can go underwater, a grant of restricted stock will almost always have some value. While stock options have more potential upside, some employees like the fact that their equity compensation won’t completely evaporate, and companies prefer the somewhat simpler accounting.

Restricted stock/RSU grant has full value based on the stock price, while the value of stock options is technically only a right to buy stock at your fixed exercise price. The true value of options depends on the stock’s appreciation above the exercise price at some future point. In a grant of restricted shares/units, however, the value of each share is readily ascertainable and is much higher than the value of a mere option. As stock options are more difficult to value and must now be expensed by your company when they are granted, companies have often cut back on them. Restricted stock also poses less risk to the employee since, most of the time, stock doesn’t go to zero. As many of you may know, stock options are quite capable of expiring out of the money instead of increasing in value.

The financial-planning rationale for this advice. This stock was given to you as part of your compensation. It was granted some time ago and vests in pieces over time. Since the market will continue to affect the remainder of the unvested portion of your grant, why take market risk with the shares you have just received? Unless you have ownership guidelines as part of your employment agreement, there is no reason to let a disproportionally large piece of your net worth be concentrated in your company stock. Most employees who receive stock grants have other equity compensation that is far from expiration or will vest in the future to be a defence against the risk that is unique to each company. For every example of a company with a long, seemingly dependable history of rising earnings, dividends, and stock prices, I can show you an example of an iconic brand-name company that has temporarily stumbled. You don’t want that to be your company,

appreciate a restricted stock grant because its monetary value in your pocket (i.e. your company's stock price) is easier to figure out than a stock option's value, which is theoretical. A stock option grant involves more shares than a comparable restricted stock grant However, stock options may never be worth anything: in the worst case, they may be underwater after vesting and for the remainder of the option term.

A majority of large companies now have stock ownership guidelines for key executives. Typically, only your vested restricted stock counts toward ownership requirements, though unvested restricted stock can count as well

Restricted stock is no longer maligned as merely "pay for a pulse," particularly as companies add performance features that trigger grant or vesting. Although experts predict that stock options will continue as the primary long-term incentive award to attract, motivate, and retain key employees and executives, the role of RSUs in particular is growing. Surveys show that it is the primary replacement for stock options. Appreciating its benefits and understanding the details of related tax and financial planning will help you maximize its value.