Pet Peave Part II

Pet Peave? What Peave?

We have a mild pet peave on companies who claw back stock option life at normal retirement—justified or plain unjust? We believe the latter. Click here if you have not seen Part I of this series.

What is our intent in Part II?

Since we believe clawing back option life at normal retirement is unjust, we will provide a more analytical perspective than in Part I. We will also explain why some companies are clawing back option life from the largest and most valuable option awards in our client grant streams.

Here’s the question that confounds us the most on this subject: Why award a vesting-related benefit to encourage loyalty and hard work and then take it away after that loyalty and hard work have been earned at retirement?

Anecdotally, the answer follows the same storyline as the old fable about the child who asks their parent why they cut the ends off the pot roast before cooking it. It’s simply how the family cooks always did it across the generations, and nobody ever questioned it. So, is the excuse “because we’ve always done it this way” a justifiable reason for injustice? Let’s leave that one in the realm of rhetorical questions, so obvious they require no answer!

Buck up, C\Suite, this is compensation, not pot roast!

Here is a core reason that cuts a bit closer to the bone given to us directly by a Senior Leader in compensation and benefits from a nameless F500 company somewhere between Chicago and LA:

  • Overhang is the potential dilution in company equity value due to A) stock options outstanding but not exercised plus B) Board approved, but not-yet-awarded, stock option inventory. Once converted to shares, this option overhang represents a dilution of earnings per share and return on capital, and certain parties don’t like that dynamic. Further, within a growing company whose headcount of potential option awardable leaders is likewise growing, there sets in a type of Demographic Warfare between active and retired employees. (I bet you didn’t see that one coming!)
  • One way to reduce overhang is to get awarded stock options off the corporate books as soon as possible. Here it comes…wait for it…
    • Reduction of option life from 10-years to 5-years at normal retirement has the impact of reducing the outstanding inventory of awarded options to the retired population of now-former leaders. This more rapid elimination of unexercised options of the retired population allows the Board to periodically authorize increasingly larger amounts of option award inventory for the benefit of currently employed leaders; hence, Demographic Warfare.
    • So, the former employer financially harms retired leaders for the sake of younger leaders still under the corporate employment umbrella. May we say: “Uffda!”
    • For a retired leader who served their time honorably, this penalty does not seem just, but in the end, what recourse does the retired leader have? None.

My friends, this is why we are writing this blog today. We speak for those who dare not speak truth to power because as a pre-retired leader, focusing on this message is akin to biting the hand that feeds you. Silence is generally the golden rule. We are the voice of the retired leader, metaphorically crying out in the wilderness, knowing that we most likely will not be heard; nevertheless, we will continue to wear burlap, eat locust, and enjoy wild honey!

If you want to discover the financial ramifications, then stay tuned!

As we posted Part I of this blog, it was in our minds to provide great statistical depth in Part II. So, we will jump right to the bottom line! That said, if a reader desires more in-depth discussion, please feel free to call us, and we will be delighted to dive deeper.

Chart #1: Normal Option Life
Year Grant Date Shares Exercised Strike Price Exercise Costs Shares Sold Exercise Price Proceeds Net Cash
2032 2/26/2022 2,400 $331.27 $795,048 2,400 $716.43 $1,719,432 $924,384
2033 2/26/2023 2,400 $357.78 $858,672 2,400 $773.74 $1,856,976 $998,304
2034 2/26/2024 2,400 $386.40 $927,360 2,400 $835.64 $2,005,536 $1,078,176
2035 2/26/2025 2,400 $417.31 $1,001,544 2,400 $902.49 $2,165,976 $1,164,432
2036 2/26/2026 2,400 $450.70 $1,081,680 2,400 $974.69 $2,339,256 $1,257,576
Totals $4,664,304 $10,087,176 $5,422,872

*for illustrative purposes only

Chart #1 demonstrates someone retiring in 2026 with a previous award string of 2,400 options per year. In this example, the retiree is given the full 10-years of life for each grant. You may recognize this by noting the last grant made 2/26/26 exercises just before 2/26/36 (10 years past grant date) with pre-tax net proceeds projected to be $1,257,576. The last five grants are estimated to provide the leader with cumulative, pre-tax net proceeds of $5,422,872 over ten years.

Chart #2: Clawback of Option Life
Year Grant Date Shares Exercised Strike Price Exercise Costs> Shares Sold Exercise Price Proceeds Net Cash
2031 2/26/2022 2,400 $331.27 $795,048 2,400 $663.36 $1,592,064 $797,016
2/26/2023 2,400 $357.78 $858,672 2,400 $663.36 $1,592,064 $733,392
2/26/2024 2,400 $386.40 $927,360 2,400 $663.36 $1,592,064 $664,704
2/26/2025 2,400 $417.31 $1,001,544 2,400 $663.36 $1,592,064 $590,520
2/26/2026 2,400 $450.70 $1,081,680 2,400 $663.36 $1,592,064 $510,384
Totals $4,664,304 $7,960,320 $3,296,016

*for illustrative purposes only

Chart #2 demonstrates the clawback of option life to 5 years from the date of the final option grant. The date of the final option grant is 2/26/26, so this last grant and all previous grants outstanding must be exercised no later than 2/26/31 (5 years from the final grant date)! Having a full 10-year life, the last grant made at retirement year 2/26/26 carried projected net proceeds of $1,257,576. Now, with a 5-year life, this same grant statistically only provides $510,384 of net proceeds. This represents a reduction in the value of 59.42% or $747,192 lost in dollar terms. Some inquiring minds might find this to be a statistically significant number! Some leaders might feel the sting of that clawback! With the truncated option life, the cumulative net proceeds of the affected option string now possess a potential for only $3,296,016, representing a 39.22% overall reduction with the lesser option life. In dollar terms, this is a potential reduction of $2,126,856. Ouch!

You may now be asking: “Are you suggesting that if a leader worked at a company that did not have a clawback of option life at retirement, they could potentially be retiring with 2.1 million dollars of additional cash?” Yes, that is exactly what this means.

A Few Final Points

The shorter the option life, the greater your statistical risk of holding that grant. Said another way, the shorter the option life, the greater the risk of poor performance or value loss in that grant. Please read that one more time. The realization is more valuable than the words sound initially!

All of that said, we know clients in this claw back situation are still multi, multi, millionaires unless they spend like drunken pirates. But, they have helped their fellow human beings by using their talents in a stimulating corporate environment! They have fully self-actualized intellectually, personally, financially, and in leadership. So perhaps all this is moot. But if a client is looking at employment in Company A vs. Company B, this issue is worth knowing about in this competitive market for executive talent.

Stoddard Barnhill
sbarnhill@thebahnsengroup.com

Phillip Barnhill
pbarnhill@thebahnsengroup.com

Sarah Leitzke
sleitzke@thebahnsengroup.com

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The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

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About the Authors

Stoddard Barnhill, CFP®

Private Wealth Advisor

Sarah Leitzke, CFP®

Private Wealth Advisor

Phil Barnhill, CLU®

Director of Risk Management

For nearly 25 years Phil has worked exclusively with senior leaders of public and large private companies. Over the past seven years Stoddard has been carefully mentored in this niche market and is now mentoring Sarah, leading to a highly-specialized practice knowledge within the team. This focus on corporate executives and their family dynamics comes with significant insights into executive compensation, stock concentration, equity monetization, and the full life-cycle of a career in the C-Suite.

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