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Chapter 5: Learn the Language of Stock Options!. By: Sulayka Silva. Peter Drucker. Is called the father of corporate management. He recognized the role of the worker in corporate success. He considered the knowledge of a good employee to be the most significant asset of the firm.
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Chapter 5: Learn the Language of Stock Options! By: Sulayka Silva
Peter Drucker • Is called the father of corporate management. • He recognized the role of the worker in corporate success. • He considered the knowledge of a good employee to be the most significant asset of the firm. • He preached the importance of managing employees in a corporate community based on trust and respect.
Peter Drucker In 1984 Drucker felt that CEO compensation was out of control. He recommended back then that it be limited to 20 times the salary of the average worker in the company.
CEO paychecksizes • By 1991, the average large-corporation CEO earned about 140 times the pay of the average worker. • And by 2003, the same CEO earned 500 times the rank and file salary.
GoldenParachutes Inside corporate executives get huge severance packages when they lose their jobs.
Howmuchdoesthiscostto a shareholder? • In 1993, the top five executives of U.S. public companies siphoned away 4.8% of company profits. • By 2003, they were able to pirate away 10.3% of the earnings of the companies they “managed.” • The total in 2003 was roughly $290 billion — ten times the 2005 discretionary budget for the Department of Homeland Security!
UnprofitableMergers Senior inside executives get even more money when they buy a new company or sell their current one as long as they negotiate the whole deal.
Executivesgetpaidevenifthecompanycrashes • The year before Refco sold shares to the public — and immediately made the fourth-largest bankruptcy filing in U.S. history — insiders at the firm sucked away more than $1 billion from the company. • US Airways CEO David Siegal collected $4.5 million upon leaving after placing the carrier in its second bankruptcy. • Procter & Gamble CEO DurkJager left the company with a package in excess of $9.5 million after overseeing a 55% drop in share price. • Morgan Stanley’s former CEO Phillip Purcell was due to receive $62 million in retirement, yet was also paid an additional $44 million plus administrative support and executive medical benefits when he recently left the financial giant under a cloud of problems.
US Airways • In mid- 1990s US Airways stock price was going up. • Stephen Wolf became chairman and RakeshGangwal was the new CEO. • The stock price of the company was so volatile that employees took advantage of the opportunity and start buying and selling their stocks in the 401(k) and making profit out of it. • Wolf and Gangwal didn’t like that, so they made it a regulation that if employees sold out the company stock in the 401(k) they had to wait 30 days to buy back in. • This made employees want to stay in the stock.
US Airways • Wolf was known for dressing up airlines and selling them. • US Airways was still profitable with about $2 billion of value. • Of course, Wolf had options going tobed. • Instead of funding the company pension plan — like he was supposed to — Wolf was buying the company stocks back from the market to prop up the stock price. • He bought the stocks back with the $2 billion in cash that non-executive employees had created by doing a great job. • This created a buying pressure that artificially inflated the stock price while Wolf and other executives sold out their employee stock options for millions before the price came crashing down. • He did this so that he could get out of his options filthy rich.
Employee Stock Options • By giving the managers of the firm employee stock options (ESOs), they would think more like shareholders — they would be motivated to maximize corporate performance and thus their own compensation. • The problem is that an increase in the stock price of the company is not caused by management’s direct actions. • Internal factors, such as great employees, or external factors like increased public interest in stock investing, have much more to do with an increase in stock price than anything management does or doesn’t do.
Options An option is a contract that gives one party a temporary right to buy an asset from another investor at a fixed price. Alternatively, an option can also grant the right to sell. Options are securities that make it possible to invest in stocks without actually owning the shares.
Stock Options Stock options are themselves securities and can be traded in financial markets. An option to buy a stock is known as a call option or just a call. An option to sell stock is known as a put option , or just a put.
TheOptionWriter The first person to sell an option contract is the person who creates it by agreeing to sell the stock at the strike price. He or she is said to write an option and is called the option writer. Once the option is written, the option contract becomes a security.
IntrinsicValue of anOption • If a stock’s current price is below the strike price in the case of a call, or above the strike price in the case of a put, we say that the option is out of the money. • If the stock’s price is above the strike price in the case of a call, or below the strike price in the case of a put, we say that the option is in the money . • When an option is in the money, it has value that doesn’t completely depend on the stock’s price moving higher in the case of a call or lower in the case of a put. This value is also called the intrinsic value of anoption.
OptionsThat Expire • Options are exercisable only over a limited period of time at the end of which they expire and become worthless. • That makes option investing very risky.
Trading In Options • An option can be bought and sold between investors at any time during the term of the normal contract. • Options on selected stocks are traded on a number of exchanges throughout the country. • The largest, oldest, and best known is the Chicago Board Options Exchange — abbreviated CBOE.
Warrants • Warrants are similar to call options but are issued by the underlying companiesthemselves. • When a warrant is exercised, the company issues new stock in return for the exercise price. • Warrants are like call options in that they give their owners the right to buy stock at a designated price over a specified time period. • They differ from stock options in that the time period is much longer, typically severalyears.
Employee Stock Options (ESOs) • For many years, American companies have given certain employees stock options as part of their compensation. • Employee stock options (ESOs) are more like warrants than traded options because they don’t expire for several years and strike prices are always set well below current prices when the options are awarded. • Employees who receive stock optionssupposedlyget less in salary than they otherwise would. • Workers like being paid with options because they don’t cost anything when issued. • Since employees who receive options supposedly get lower salaries, the practice supposedly improves the company’s financial statements by lowering payroll costs.
