My company has recently announced that it is giving its employees option to choose between Restricted Stock Unit (RSU) and Stock Options for our Stock Focal Program. The Stock Focal Program is a benefit given to employees as a reward for their contributions. The reward is based on the perceived potential of the employee and depending on that perception, the employee receives a certain number of RSU or options.
To start we have to define RSU and Stock Option first.
What are Stock Options?
A privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed-upon price within a certain period or on a specific date.
What are Restricted Stock Unit? RSU stands for what kind of stock?
Restricted stock is, by definition, stock that has been granted to an executive or employee that is nontransferable and subject to forfeiture under certain conditions, such as termination of employment or failure to meet either corporate or personal performance benchmarks. Restricted stock also generally becomes available to the recipient under a graded vesting schedule that lasts for several years.
The two definitions were lifted from investopedia so I'm giving another example to make it easier to understand.
Stock Options are rights to buy a stock. For example, Company ABC gives employee D an option to buy 12,000 stocks at $10 vesting for 5 years beginning November 1, 2010 vesting monthly.
This means that Employee D can buy Company ABC's stock for $10. Since this is vesting monthly, Employee D receives 200 stocks per month starting December 1, 2010 (12,000 divided by 60 months). His gain is depending on the trading value of Company's ABC stock.
To illustrate, if on December 1 2010, Company ABC's stock trades at $5, Employee D stands to gain nothing because his grant price is $10. With this example, it is said that options are "under water". On the other hand, if the market price of the stock is at $15 on December 1, 2010, Employee D stands to gain $5 ($15 - $10).
This means that Employee gain is dependent on how much the stock will perform after he receives his grant. In our example, if the stock fell down from $10 after the grant date and never increases above ten, employee D gains nothing.
This means that Employee D can buy Company ABC's stock for $10. Since this is vesting monthly, Employee D receives 200 stocks per month starting December 1, 2010 (12,000 divided by 60 months). His gain is depending on the trading value of Company's ABC stock.
To illustrate, if on December 1 2010, Company ABC's stock trades at $5, Employee D stands to gain nothing because his grant price is $10. With this example, it is said that options are "under water". On the other hand, if the market price of the stock is at $15 on December 1, 2010, Employee D stands to gain $5 ($15 - $10).
This means that Employee gain is dependent on how much the stock will perform after he receives his grant. In our example, if the stock fell down from $10 after the grant date and never increases above ten, employee D gains nothing.
Restricted Stock Unit on the other hand are like stock options without grant price. In our example above, if Employee D is given RSU of 4,000 vesting for 5 years beginning November 1, 2010 vesting annually, Employee D stands to receive 800 RSU every year. If Company ABC's stock trades at $10 a year after, Employee D earns $8,000.
To further illustrate,
If on November 1, 2011, Company's ABC stock is trading at $10 and Employee D decides to exercise his options or sell his stock, he will not earn from stock options because the grant price is equal to stock price. With RSU, he will receive 800 times $10 or $8,000.
Now, assume that on November 1, 2011, Company's ABC stock performed well and is now trading at $20. With Stock Option, Employee D stands to earn $20 minus $10 times 2,400 or $24,000. With RSU, the employee will earn 800 times $20 or $16,000.
Now, assume that on November 1, 2011, Company's ABC stock underperformed and is now trading at $5. With Stock Option, Employee D earns nothing because the stock is underwater (grant price higher that market price). With Restricted Stock Options, Employee D earns 800 times $5 or $4,000.
To summarize our example, it seems that selecting Stock Options is more favorable if the stock price is expected to increase through time from the stock grant date. If the stocks is not expected to perform above the stock price on the grant date, RSU seems the better option.
Vesting Type Consideration
Another thing to look at and consider is the vesting type. RSU is vesting annually while Stock Options vests monthly. Given the same period of five years, If Employee D has no plans of staying within the five years vesting period Employee D should prefer stock options because Employee D will receive options every month with the assumption that stock price will increase over time. If Employee D resigns five months after the grant date, Employee D can at least receive 1,000 options. With RSU, resigning five months after the grant date will have Employee D receiving nothing. It must be noted, however, that stock price after five months should be higher than the grant price. If not the 1,000 options received by Employee D are under water so it is also worthless.
Assuming Employee D stays for one year and stock price increased to $11, with RSU he stands to earn $11 times 800 or $8,800. With Stock Options, he stand to earn $11-$10 times 2,400 or $2,400.
But in both scenario, Employee D stands to earn more if he elect to stays five years. After all, this is just a reward with no cost to the employee.
Tax Consideration
In all of our examples, we have not considered taxation. Remember that RSU's are taxed at vest date. Stock Options on the other hand, are taxed on the exercise date based on the difference of the stock price and grant price. For Non-US residents, taxation differs. Again, it is always better to consult your CPA regarding tax matters.
Summary
Using the illustrations above as basis for conclusion, stock options are favorable if stock price is expected to increase and the employee has plans of not staying for five years. Restricted Stock Unit on the other hand is a less risky choice for those intending to stay and do not expect the stock price to perform well above the grant price.
What do you think?
Note: This is no way intended to serve as an advice. While I am a CPA here in the Philippines, i do suggest you consult your CPA for tax implications as well. This entry is just based on my own analysis.
