Earlier this year, we blogged about the potential stock comp wealth (and related tax issues) that seemed certain to blossom for Facebook employees amid the company's much-hyped initial public offering in May. Time and the market have popped these balloons of expectation. Although investors were predicted to "like" Facebook stock in huge numbers, skepticism about the company's valuation and prospects has prompted significant investor flight over the past few weeks. The surprising plunge in the stock price has created unexpected difficulties for the company's equity compensation.
Angst among Facebook employees about their equity awards has been widely reported (e.g. by Reuters and Business Insider). While the expiration date of the lockup on most employee shares (almost 50% of total shares outstanding) is still fairly far off (Nov. 14), Reuters notes that some employees are already adjusting their expectations because of the poor post-IPO performance. Many now plan to sell a smaller portion of their stake in the company than they otherwise would have if the stock price had risen or even just stayed flat. "I will definitely take some," said an employee anonymously quoted in the news report. "But my debate is how much." The article in Business Insider wonders whether Facebook may develop problems with employee retention, at least in the short term.
Additionally, Facebook needs to raise cash for the taxes ($2.5–4 billion) incurred by its share withholding at RSU vesting, and it has been planning to sell shares to cover this. Because of the fallen stock price, financing that tax bill will now be more difficult than expected.
Facebook employees who joined the company during the past 18 months (perhaps half its workforce) were granted restricted stock units (RSUs). This is fortunate for them. Unless the underlying stock price drops to zero, RSUs always have some value. Stock options, by contrast, would be well underwater, as the exercise price would reflect the pre-IPO stock valuation—much higher than the current depressed price. Before the IPO, various option-valuation models gave Facebook stock a worth of $24.10 during the first quarter of 2011 and around $31 in the first quarter of 2012. Now that the stock price is below these thresholds, the golden handcuff would have lost its lure for restless employees.
In this blog we have also discussed Zynga's pre-IPO demand for nonproductive employees to give back large unvested stock grants. Bloomberg has revealed that Zynga is now broadly granting stock options to retain staff after a fall in the company's stock price. Like Facebook, Zynga had previously granted mostly RSUs. The reasoning behind the switch seems clear. Stock options have much more upside than restricted stock. In short, you get more options per grant, and the fixed purchase (exercise) price provides investment leverage. As a result, options have the power to generate much greater wealth from stock-price appreciation than restricted stock/RSUs do. This, in turn, may help to keep employees at the company.
If Facebook believes its stock is unreasonably depressed, we wonder whether it too will start proffering the golden carrot of stock options to motivate and retain employees. This move could also signal some much-needed optimism about Facebook stock. If or when the stock price does rise, these options would be much more valuable and attractive than RSU grants.
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