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Google's Repricing of Options

By - January 23, 2009

Google yesterday announced it would offer a repricing program for its options holding employees, a move that acknowledges and addresses the reality that Google’s stock has sunk, like most others, well below strike prices. Google plans to take a $460 million charge for the move.

The WSJ picks up on the news and offers a perspective (the post is behind a pay wall):

…options are also meant to align interests with shareholders — so if the price soars, both benefit. If the price drops, both suffer. If Google is going to reprice when things go wrong, it should also limit the upside to employees. It would be easier simply to pay bonuses instead, tied to corporate performance, with a portion in stock that vests over time to aid retention … when shareholders do add up the cost of options, the answer can be shocking. Albert Meyer, president of money manager Bastiat Capital, calculates that since 1995, Cisco Systems has spent $30 billion — or nearly half its free cash flow in that period — buying back stock issued as a result of employee options exercises.

Update – more from Adam here. Good overview of earnings, notes only *100* new employees in the quarter, that is a major shift (on a base of 20K) and this:

Google is transferring almost half a billion dollars in wealth from shareholders to employees, and for what ….? Motivation and retention, says Google. This a well known farce, as old as the Valley, which tells itself first that it offers generous stock options as a form of incentive and then, when share prices plummet, moves the ball so its employees, whose incentives apparently didn’t work (as if the stock price were under their control) can be re-incentivized. Retention? Would someone please tell me where the average Google employee is going to go right now?

In conclusion, and as the headline says, Google is in good shape. Not fantastic. But plenty damn good. It’s also becoming more and more like other technology companies in so many ways.

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10 thoughts on “Google's Repricing of Options

  1. David King says:

    460 Billion?

    wow, that’s a little change.

    almost half a billion!

  2. Kamal Jain says:

    Some of my friends who joined Google got both stock awards and stock options. This was Google’s way of blending the risk with reward for the employees.

    I, with the help of one of my interns, looked at this type of blending, with another kind of blending where only the options are given but the strike price is lowered (such as half of what the stock price on the day is). The numbers of the options are appropriately adjusted to keep the cost to the employer the same.

    Note that a stock is also an option with a strike price of 0. So Google’s package was granting two types of options, some options with the strike price of 0 and some with the strikeprice equal to the market price of the stock on the day. What we came up with that instead of granting these two types of stock based packages, a company would maximize the incentives for the employees if a single package of options with lowered strike price, such as half of the market price of the stock on the day, is granted. We assumed that the market value of the package is fixed. (My intern wrote a program to find the optimal tradeoff.)

    Basically we define the incentive ratio of the package as follows. Assume that the stock price goes up by a dollar, then what is the increase in the personal wealth of the employee. We then take the average of this ratio over the life time of the stock based compensation package.

    What Google is doing this quarter is a validation of our work. If Google had combined the stock with stock option the way, we showed is optimal, instead of the way it actually did, then Google would not be repricing the stock options today. An expected gain of a 9 figure sum.

    Another thing on simulations the program showed is that with such a package, options is an effective incentive alignment tool for value companies too as it is for growth companies.

    Disclaimer: The results were not mathematically proven, but were empirically based on the simulation of a computer program. The program was not tested so could have bugs too. It was written to give us some validation, because the math was too complicated (complicated enough that we could not complete it.)

  3. Kamal Jain says:

    Some of my friends who joined Google got both stock awards and stock options. This was Google’s way of blending the risk with reward for the employees.

    I, with the help of one of my interns, looked at this type of blending, with another kind of blending where only the options are given but the strike price is lowered (such as half of what the stock price on the day is). The numbers of the options are appropriately adjusted to keep the cost to the employer the same.

    Note that a stock is also an option with a strike price of 0. So Google’s package was granting two types of options, some options with the strike price of 0 and some with the strikeprice equal to the market price of the stock on the day. What we came up with that instead of granting these two types of stock based packages, a company would maximize the incentives for the employees if a single package of options with lowered strike price, such as half of the market price of the stock on the day, is granted. We assumed that the market value of the package is fixed. (My intern wrote a program to find the optimal tradeoff.)

    Basically we define the incentive ratio of the package as follows. Assume that the stock price goes up by a dollar, then what is the increase in the personal wealth of the employee. We then take the average of this ratio over the life time of the stock based compensation package.

    What Google is doing this quarter is a validation of our work. If Google had combined the stock with stock option the way, we showed is optimal, instead of the way it actually did, then Google would not be repricing the stock options today. An expected gain of a 9 figure sum.

    Another thing on simulations the program showed is that with such a package, options is an effective incentive alignment tool for value companies too as it is for growth companies.

    Disclaimer: The results were not mathematically proven, but were empirically based on the simulations of a computer program. The program was not tested so could have bugs too. It was written to give us some validation, because the math was too complicated (complicated enough that we could not complete it.)

  4. Nakliyat says:

    The number of Google shares subject to outstanding options will not change as a result of this employee-only option exchange. The total number of options expected to be exchanged in this program represents less than 3% of total shares currently outstanding.

    We expect to take a modification charge estimated to be $460 million over the vesting periods of the new options. These vesting periods range from six months to approximately five years. This modification charge will be recorded as additional stock based compensation beginning in the first quarter of 2009. This estimate assumes an exchange price of approximately $300 per share and that all eligible underwater options will be exchanged under this program. As a result, this estimate is subject to change.

    If you’re interested in learning more about this employee-only stock option exchange, we encourage you to read our related SEC filings when they become available.

  5. John says:

    The $460 million charge is small change for Google in order to keep their best employees.

  6. ttnet says:

    Generally, all Googlers with options are eligible to participate (Eric Schmidt, Sergey Brin, and Larry Page do not hold options) except where precluded by legal and tax issues in certain countries. We are working to address these issues and the final offer documentation will specify any countries in which we are not able to offer the program.

  7. Trottoria says:

    Here is a great Eric Schmidt quote that does a great job defending the reprice:

    ‘“Would you prefer we had the Wall Street firm’s bonus model? That doesn’t seem a very good model to me.”

  8. Brian says:

    Great quote by Eric Schmidt. You have to keep your employees happy to keep top talent. You can’t run your company to satisfy Wall Street.

  9. Curtis says:

    I think the re-pricing concept is silly, and think there are better ways to handle keeping folks incentivized after a share price drop.

    However, I’m not sure why G is getting so beat up about it…..it’s not like they invented the concept…..it’s been around for ages.

  10. Artı Emlak says:

    The number of Google shares subject to outstanding options will not change as a result of this employee-only option exchange. The total number of options expected to be exchanged in this program represents less than 3% of total shares currently outstanding.

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