December 13, 2006

Late yesterday, Google announced plans to begin a rather unique stock options program that will allow its employees to dispose of their vested options in an online stock auction.

The program is slated to begin in April 2007.

Up until today, various employees had two ways to deal with stock options: exercise them (buying the stock) once they have "vested" and/or sell them on a public stock exchange at their current trading price, and then pay back their employer for their so-called striking price, or simply hold on to them after exercising them.

Google executives believe big buyers of Google "options" on the public markets may see auctions as a place to bargain hunt. However, the financial institution buying the options assumes a risk: mainly, that Google's stock will keep going up.

Google's new TSO (Transferable Stock Option) program gives nonexecutive Google employees a third option: a secondary market of sorts managed by Morgan Stanley where pre-approved financial institutions can bid on vested options.

However, it won't apply to options granted prior to the search giant's initial public offering.

For employees who have arrived at Google long after its stock price started to climb, the auction potentially presents a more profitable alternative to trading on the public markets. It would work like this: once an employee's options are vested, he or she can look for bidders in the private auction.

A financial institution may offer the employee, for example, $150 per option. If the employee's strike price was $400 and the stock was trading at $500, the employee would have made $50 more per option going the auction route rather than selling them on the public market. Employees can also set a minimum price at which to sell if they prefer.

So why is Google doing this? Executives say it's to make things fair for newer employees. The company's stock closed trading yesterday at $481.78 and, despite its long, upward climb, some justifiably wonder how high the stock price can go and whether the options for newer employees will be worth anything when they vest.

Google's employee stock options vest after four years and typically expire after 10 years.

"Our expectation is that banks would be willing to pay employees a premium for the right to continue holding the stock," said Dave Rolefson, equity and executive compensation manager at Google.

Google co-founder Sergey Brin was an early proponent of the auction system, which he saw as a way to improve the fairness of the options system for newer employees whose strike prices are much higher than people even hired shortly before them, said Allan Brown, director of recognition and human resource systems at Google.

Financial experts who have been briefed on the program say it's certainly innovative, but wonder how many Google employees will opt for it rather than rolling with the company's seemingly ever-increasing stock price.

"It's very creative and innovative-- exactly what you would expect from Google," but it's likely Googlers will choose to sell rather than hold onto options, said Nell Minow, editor at The Corporate Library, an independent research firm specializing in corporate governance. "The question is, given that it would defy the law of physics for this stock to continue to perform at the level it has since the company went public, is the smart money going to go for cashing out more quickly or for holding on?"

But Silicon Valley employees, in particular, "are more used to seeing a $550 stock drop to $10 than rise to $1,000.

The perceived value is much less than the financial calculated value," said Ted Buyniski, a compensation consultant at Radford Surveys + Consulting. "This enables Google to close that perception gap."

Google's accounting will not change as a result of the new program, but the amount of stock-based compensation expense will be higher than it would be if not for the program, said Mark Fuchs, chief accountant for Google.

The company said it has discussed the program with the SEC (Securities & Exchange Commission).

News of Google's innovative stock options plan provoked "mild grousing" from one shareholder advocate who said companies should not encourage employees to sell options, or even sell stock in general, in the company because it could lessen the incentive for employees to contribute at their jobs.

Source: C-Net News