The Non-Option: Understanding the Dearth of Discounted Employee Stock Options
David I. Walker
Associate Professor, Boston University School of Law
Boston University School of Law Working Paper 08-30
Forthcoming, Boston University Law Review (2009)
Abstract
U.S. companies are highly sensitive to the tax and accounting treatment of compensation arrangements. For more than fifty years, congressional tax writers and the accounting profession have singled out discounted or “in-the-money” employee stock options, options with exercise prices less than the fair market value of the underlying stock at grant, for special, disadvantageous, treatment relative to non-discounted options. Today we observe no discounted options, but instead commonly observe a second best compensation solution – contemporaneous grants of both stock and non-discounted options to individual employees of U.S. public companies. Given the ability to work around the barriers to explicit discounting in this fashion, this article explores whether the regulatory distinction between discounted and non-discounted options makes sense.
The stated legislative rationales for rules discriminating against explicitly discounted options are weak, reflecting a dichotomous view of equity compensation divided between discounted and non-discounted options, when, in fact, option design is a continuum. By contrast, this article sets forth a novel tax policy rationale for forcing firms to bifurcate in-the-money long-term incentive pay arrangements into discrete grants of stock and non-discounted options. In short, doing so precludes the unwarranted expansion of preferential option tax treatment to deeply discounted options resembling stock.
Cite as:
Walker, David I., "The Non-Option: Understanding the Dearth of Discounted Employee Stock Options," forthcoming Boston University Law Review (2009).
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David I. Walker Contact Information
Boston University School of Law
765 Commonwealth Avenue
Boston, MA 02215
Email Address: diwalker@bu.edu
Phone: (617) 353-3174