Executive Compensation - Cash or Additional Company Exposure
This time of year is normally the time that clients who have bonuses and executive compensation need to make choices in regards to receiving these benefits as cash, company stock options or company restricted share units (RSUs). Like most decisions, there are advantages and disadvantages to each and no one right answer for everyone.
A primary benefit of receiving cash is that it is available to re-deploy to other priorities such as additional portfolio diversification, college savings, identified priority spending, etc. Another key benefit is that it does not increase concentration in your employer stock. Two potential disadvantages include needing to pay current income tax at potentially higher marginal tax rates given higher incomes and secondly, the loss of potential upside growth from the appreciation of company stock from participation in the stock options or RSUs programs available.
The potential growth opportunity of both stock options and RSUs is certainly appealing. Both have a disadvantage in that the funds are not immediately available and likely increase what might already be a larger employer stock concentration that you would like. For many executives, employer stock concentration can be a real challenge which is important to recognize and proactively manage. RSUs normally have the benefit of vesting sooner than stock options and given they are fully taxed at the time of vesting are normally available to liquidate and re-deploy funds sooner. Unlike stock options where the economic benefit is based on a certain stock price in excess of a stated grant price, the RSUs are normally not dependent on a grant price and therefore unless the stock price goes to $0 per share, will have some value.
Given that most stock options normally have a 10-year or longer expiration period, the potential upside with an appreciating stock can be substantial and likely more than with RSUs as most companies would issue more stock options or less RSUs for the same targeted dollar benefit to the employee. As mentioned above, if the company stock price declines, the stock options can be worthless whereas RSUs are likely to maintain some value as long as the stock price doesn’t go to $0.
Many companies allow employees to allocate a portion of their executive compensation among all three options (cash, stock options, and RSUs) based on an annual election percentage split which could allow one to balance the advantages and disadvantages of the different options available and tailor the elections to one’s own personal comfort level.
As mentioned above, there are pros and cons to each of these choices and no “one size fits all” is readily apparent. These choices illustrate why it is important to make decisions like these as part of a holistic comprehensive wealth management strategy considering key areas like portfolio diversification, cash flow and taxes, and retirement income planning opportunities. Feel free to give us a call to talk further about your situation and how our strategies and expertise might be able to help.
Disclaimer: No two executive compensation programs are the same and this is a general discussion of potential options based on common executive compensation programs available. This is not specific advice for any one individual and should not be relied on to make any decisions without first contacting a professional to review your individual situation.