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December 13, 2006



this is great... what about skype finally charging for calls?


Here's one.


It's a win-win-win


Any concerns about disparities in information giving the institutions participating an advantage over the individual investor? When Google's got non-public material information, they say they're going to turn this program off, which is a pretty strong indicator that volatility's coming, no? Yet only the institutions participating in the program will have access to this indicator.

In general, I agree - very sharp, very interesting idea.


This looks to me like another indication Google won't split their stock. Part of the reason for this plan is probably the amount of money it takes someone to exercise their options. 100 call options expiring Friday at $450 would require $45000, just to make $3000.

Don Dodge

Henry, I think this is a win/win/win for employees, Google, and shareholders. The TSO program is great for all employees but it really looks good when an employees options are under water.

Lets say you joined Google a year ago when the stock was at $475 a share. Your options were granted with an exercise price of $475, vesting 25% per year over 4 years. But here you are a year later and the stock is trading at $478. You have only made $3 per share? Wow! not what you expected right?

Options traders are willing to pay a lot more than $3 for your option because it doesn't expire for another 2 years. Today, a January 2009 option to buy Google at $470 (option symbol -OUPAU) is trading at $110. Wow! That option you thought was only worth $3 is really worth $110.

Employees who joined Google last month when the stock was $513 per share are now $35 per share under water and thinking maybe this wasn't such a smart move. Think again. Some of their options will vest in November 2007 and expire in November 2009. The value of that "under-water" option today is somewhat over $90 today.

I know you understand all this stuff, but many tech people don't. I wrote an indepth blog about how the options work and why investors are willing to pay more for them. See

Don Dodge


Another subtle positive for the shareholders: the weighted shares outstanding (WSOS)at any point of time in the future would be less than it would have been under the old system. Why? Instead of exercising and sell (thus converting options to shares on a 1:1 basis), employee will, in their right mind, sell the options to institutional investors. Thus, prolonging the life of these options. When calculating WSOS, these options will be translated into fewer shares. So essentially, because of this program, Google's future EPS would be higher than it would have been otherwise.

Neal S. Lachman

This whole sceheme is a bomb. I agree with all points made by Scott Cleland. His analysis is a terrific one and underlines the threats to Google's shareholders/stock (option) owners.

The "what if/yeah but..." scenarios that Don Dodge and you point out here are only keeping in mind some of the upsides, while the downsides are terribly and dominantly present. I also agree with Stephen's comment that you have to risk a whole lot of money just to make a few bucks. This is yet another downside of an expensive stock.


We are talking about new incentive plan here, apart from usual "world spread" innovation I can find only one Real reason: stock is not going much higher and Insiders are the best people to know it and are not ready to work just for salary and worthless stock options. Apart from latest hype Google did not make much this year as stock, slowing growth and rising Capex will compress Free Cash Flow and stock will fall, technical picture is telling about it very loudly.


Here are the problems I see with the program, as posted elsewhere:

1) Disloyal and departing employees are the primary beneficiaries. Indeed, Google has acknowledged that they will have significantly higher options expenses, estimating a 2 year increase in the average time to expiration of employee options. The additional expense is a wealth transfer from Google shareholders to people who will soon be ex-employees. (Employees who expect to stay more than 2 years but sell their options anyway are losing money and lowering Google's options expense. However Google clearly doesn't estimate this to be a major factor, and nor do I.)

2) Loyal but strongly risk averse employees may benefit since they can diversify out of Google stock without throwing away all the time value of their options. They take an accounting loss with the reduction in time value, but maximize their utility from the reduction in risk. Empirically, many employee stock option grantees behave this way, I certainly do. However, the whole idea of stock options is to incent employees through the stock price. An employee who takes advantage of the program will lose that incentive. So despite increasing Google's options expense, this will reduce the effectiveness of the program as an incentive. All bad for shareholders.

3) Loyal employees who believe Google is overpriced may benefit since they can excercise their options and capture the high market price without throwing away all their time value. If this is in fact a real concern for a large number of Google employees, and if Google's management can think of no better solution to that problem than to accomodate those employees with this program, then that is very bad news for shareholders.

4) Google management may themselves believe Google is overpriced, hence they wish to subtly encourage their employees to transfer that market risk to third parties while they can. This is of course an even worse theory as far as shareholders are concerned.

5) Poorly informed employees may be underestimating the value of their options, which would affect employee retention. A Google spokesman made this claim to justify the program. This is quite possible, but it's mind-boggling that Google would incur some $100 million a year in additional option expenses annually just to educate their employees on this point. GOOG has 2 year LEAPS exchange traded options which will be quite close to the value of transferrable employee options, so there is already market price discovery for Google options. Indeed, loyal employees would achieve a similar result to thsi program by selling call options on the open market. Theoretical valuation models can also give a good idea of how much an employee stock option is worth. I know it's an esoteric topic, but Google supposedly hires the very best and the brightest. Does Google's management have so low an opinion of their employees that they believe them impervious to any explanation but cold hard cash?


Now to respond to your points and Clelands:

1) Less dilution. Wrong! To whatever extent this program increases the value of employee stock options, it also increases dilution of shareholders. Even if Google issues fewer options, those options will have a longer lifetime by 2 years (Google's own numbers) making them more likely to be exercised and increasing their theoretical value. It is mathematically impossible for the options to actually be more valuble to employees without being more expensive for shareholders in terms of dilution.

2) Retains risk sharing. Wrong! By definition, anyone who actually takes advantage of the program by transferring their option is by definition no longer sharing risk and no longer incentivized by their options. So to whatever extent employees take advantage of this program, they are escaping the intent of a stock option grant.

3) Less risk of repricing. Perhaps, but companies shouldn't reprice stock options, period. That they chose one shareholder-hostile program as an alternative to another shareholder-hostile program (repricing) hardly seems like a ringing endorsement.

As for Cleland's points:

1) Since this program only provides a objective financial incentive for those who expect to leave the company in less than 2 years, it certainly does reward disloyalty, as I pointed out in my last post.

2) The amount of dilution depends on more than just how many options are granted; it depends on how long they remain exercisable. By increasing this period, Google is increasing the dilution potential of existing options.

Henry Blodget

Thanks for the smart and thoughtful comments.

Before challenging some of the above, I think it is important to draw a hard line between the question of 1) whether the new program is "signaling" Google's opinion that the stock is overvalued, and 2) whether a transferable option program is a net benefit on its own. Many of Scott's and your objections seem directed at the first question, which is fine. I think it is quite possible that Google thinks the stock is overvalued (or that current and future employees think so), but I'm not addressing the "signaling" question.

On the "increased dilution" and "$100 million in additional option expense," I still think the implicit assumption is that Google will issue exactly the same number of options even though each is worth more. I don't see why it would do this (and the release said as much). More likely, it will issue fewer options.

Agreed that the dilution also depends in part on how long the options remain exercisable. As I understand it, the new options will have the same life--10 years--and, therefore, will technically be exercisable for the same amount of time. If, as you suggest, Google employees rush to transfer them, the lives will suddenly be shortened to two years. If they were then exercised within this period, there would indeed be more dilution per option-issued than with the current plan. But there are a lot of "ifs" here, and estimating the exact differences is difficult. As long as Google issues significantly fewer options under the new plan, the dilution effect of accelerated exercise should be minimal.

I still don't follow the "rewards disloyalty" point. The options vest on exactly the same schedule as the current plan. Under the current plan, an employee can leave the company and keep all vested options--and hold them for 10 years while current employees sweat on their behalf. Or they can cash out at any time, as long as the options are in the money. The only thing that is different about the new plan is that they can cash out even if the options are out of the money and that they can get more cash per-option (but have fewer options) if the options still have a lot of life left. So I just don't understand this idea that transferable options "reward disloyalty." One could presumably say the same for regular options (you can leave the company and take your options with you!) or, for that matter, cash (you can take the money and run!).


I was speculating about whether Google employees or management consider their stock overpriced simply because this program doesn't seem to make sense otherwise. Since the stated reasons don't hold water (in my opinion), I naturally want to speculate about the underlying reason. But I do agree that that's another discussion and seperate from the questions you raised. It wasn't intended as a rebuttal of your argument.

As for rebuttal :)...

Google may issue fewer options to employees, but I would be very surprised if this program on its own allows them to reduce option grants to the point where it becomes a net positive for rational shareholders; that would mean that it is a net negative for rational employees.

I do agree that it will be hard to estimate how this affects the lifetime of employee options. However, Google has done the heavy lifting for us. In order to expense stock options, they have to estimate the average lifetime of those options. They have said that they are increasing this metric from 4.5 to 6.5 years as a result of the transferrable options program. In accounting terms, this is an unequivocal statement that they believe the program will be quite expensive to shareholders.

As far as rewarding disloyalty, I think you have a factual misunderstanding of how employee options work. They are always cancelled within a short period (60 to 90 days) after termination of employment. That's written into the options grant. Without transferrable options, departing employees have to exercise within a short time, and in doing so, they sacrifice all remaining time value. With this program, departing employees can sell their options instead of exercising them, and capture 2 years of time value. That is why departing employees are the principal beneficiary of this program.

Mike Bijon

The whole idea sounds like Warren Buffet was involved.

Larry & Sergey are know to contact him for advice regularly and he's known to have disparaged "excessive" options grants in the past. Hopefully this one spreads. While not perfect, it's a good alternative to typical options grants for companies that are mature enough to need to worry about stockholders but who still need to compete with the upside-potential of competing startups.


So now I'm intrigued: Who is right about the cancellation of (specifically) Google options - Henry or Sparohok?

John Olagues

The Google transferable options is a loser for Google and a winner for the Morgan Brokers, with a small advantage for the employees.

See my article at on the subject.

Do you realy think that the Morgan brokers will pay anywhere near theoretical value for the ESOs?




I haven't read Google options grants specifically, but it's a standard fixture of employee stock options. I've never heard of anyone being able to keep their options after they leave a Silicon Valley company, and I've had my own options cancelled after leaving companies. It's hard to imagine why Google would do differently. I'll ask around though.


Honestly, I think it'll be pretty competitive. There are lots of hedge funds and options market makers who have the tools to buy these options and hedge them successfully. If I were to guess, I imagine that employees will get paid about 5% below market implied volatility. That's what I'd bid if I were in the business of making markets on options. The spread on exchange traded 2 year Google LEAPS is about 2%. It'll be a bit more expensive to make a market in employee options due to the unique back end and legal, and they will be making a one sided market. Otherwise, I can't imagine why Google wouldn't get competitive quotes.

The alternative, as you point out on your web site, is for employees to write exchange traded calls. I also mentioned that in an earlier comment here. However I was under the impression that employment contracts frequently prohibit such transactions. That's just a rumor though, I've never looked into it. Can you shed any light on that?

Sam E. Antar (former Crazy Eddie CFO & ex-felon)

Who should not Receive Stock Options at Google?

Little attention is paid to the issue of who should not receive stock options. Specifically in the case of Google, all members of the company’s “independent” Audit Committee of the Board of Directors are compensated with stock options (Source: Google Schedule 14-A).

According to Google’s Audit Committee Charter its purpose is:

“The main function of the Audit Committee is to oversee Google’s accounting and financial reporting processes, internal systems of control, independent auditor relationships and audits of Google’s consolidated financial statements. The Audit Committee is also responsible for determining the appointment of Google’s independent auditors and any change in that appointment, and for ensuring the auditors’ independence.”

The Charter specifies that:

“The Audit Committee shall be made up of at least three (3) independent members of the Board of Directors.”

While I am quite sure that Google’s Audit Committee members are “independent” as defined under various regulations in substance such members cannot exercise independence if they receive earnings based compensation such as stock options or own stock in Google.

Google’s auditors are not allowed own stock in their audit clients. However, the Audit Committee which oversees the entire financial reporting process including the auditors can own stock and receive earnings based compensation such as stock options.

The awarding of earnings based compensation such as stock options to Audit Committee members provides a disincentive to effective independent oversight and has a corrosive effect on their objectivity and professional skepticism.

Therefore, I believe that Google’s policy of awarding its Audit Committee members earnings based compensation such as stock options violates the spirit of existing regulations governing the independence of such Committees.


Sam E. Antar

Neal S. Lachman


You are definately right. I enjoyed reading your comments. I have been involved (responsible even) in granting stock to employees/execs at start-up companies, and we have the same vesting/excercising/cancelling strategies. I don't think Google has changed this strategy, else it would be even more lethal to normal shareholders. In that case the leaving employee is rewarded with unprecedented freedom.


I didn't know about the rewarding structure for Google's Audit committee. I think you are 100% right if that is the case. I am going to visit your blog and read about it.


can anyone here pls explain why other companies have not done it so far?

Neal S. Lachman


I think others haven't done it because it is a bomb. It is NOT a good development at all. And don't you think others may have thought about these kind of schemes, but chose NOT to do it?

Sam E. Antar (former Crazy Eddie CFO & ex-felon)


There are no legal restrictions on so called "independent" Audit Committees owning stock. It defies logic that if they are "independent" and have such responsibilities as watching the independent external auditors they can own company stock when the external auditors cannot own stock.

Google is not alone in this regards but it does not make it right even if it is legal.

You should go to the SEC Edgar database for more information and look up Schedule 14-A.


I am a first time visitor here and commend you on your excellent blog.




I believe that the options expire 2 years after they are sold. They do not get the 10 year expiration, but are capped at 2 years after the employee sells them.

I think this is to get around the issue where the options would normally expire 30 or 90 days after the employee left the company.

There is no blatent downside that I can see with this deal, just a potentially subtle one for existing shareholders, in that the employees are given a new way to make money off their options, while transferring risk. Hopefully, those that are taking on the risk, are not paying too much for the right for that risk.

Neal S. Lachman


Thanks. I guessed already that it is not regulated as such, but I agree that it defies logic.

I often work with a Board of Advisors, and these people all get rewarded with equity, but there is no suggestion made that the members of the BoA are independent. And these are start-ups or early stage comps, not $150B, public companies.

If Google wants to "innovate" the way public companies work and operate, and "not be evil", let them also change the way their independent auditing committee is rewarded.


We're waaaay late to this exchange but nobody seemed to comment on the impact of Google's new program on the on-going cost of buying collars? Aren't some of these $100+ call/put premiums driven up because one is sold to generate the cash to pay for the other? Making them essentially "free" to the employee/buyer?

What happens now when a ton of calls get sold via this new program? Does it drive down the cost to buy a call? Do cheaper calls, in turn, affect the cost of puts?

With cheaper near-strike puts & calls, does (implied or actual) volatility increase? At the very least, it would seem to get cheaper for non-employees to speculate on the stock...

Does any of this matter?


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