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The wild thing is, if ones accepts modern financial theory, from the eyes of a risk-neutral investor, stock-based compensation is actually much more costly beca

by GASCap 6y ago

The wild thing is, if ones accepts modern financial theory, from the eyes of a risk-neutral investor, stock-based compensation is actually much more costly because of imbedded option value and time value of money. Say one needed to hedge the other side of a 4y employee stock grant. Let's assume the new cliff-less, monthly vest structure that is now market at some of FAANG. The counter-party would need to borrow a large amount of money to buy some fraction of the shares that the employee is likely to vest based on historical data. This also assumes they are just "delta hedging." There is definitely a "negatively convex" situation where if the stock price increases employees are less likely to leave and if it goes down, employees will find a new job that pays market. Given the immense volatility in earlier stage companies, the counter-party may elect to hedge the gamma exposure as well, meaning they may need to buy calls in the open market against the RSU position. In my opinion, Netflix has realized this, and given the implications decided to just pay cash. Dollar for dollar, to a well enough capitalized employee, the stock package is much better. This advantage increases with the volatility of the underlying asset. This completely ignores the career risk of working for a failed startup, but the culture in SV seems to minimize that.

nullc 6y ago
There is nothing that forces companies to fix the amount of stock ahead of time-- they do so for the retention benefit of triggering loss aversion. If that benefit wasn't worth the cost, they could drop it.
kelnos 6y ago
Not sure I get this; who is this "counter party" you are referring to? My understanding was that the company doesn't actually buy shares on the open market when an employee vests RSUs or exercises options, but instead they either have a pool of shares waiting around (which they've never sold before), or they just mint new shares (and dilute existing investors). For the pool structure, sure, there's an opportunity cost (the company could instead sell those shares on the public market). But in neither case does the company have to go out and spend money to buy up shares.
- GASCap 6y ago
  In modern financial theory valuation = cost of replicating the position. One can approach that cost from how the company or the employee would replicate it. My point here is that it is much more expensive than just paying the employee cash due to the optionality and the financing costs associated with such.

by GASCap 6y ago

nullc 6y ago

There is nothing that forces companies to fix the amount of stock ahead of time-- they do so for the retention benefit of triggering loss aversion. If that benefit wasn't worth the cost, they could drop it.

kelnos 6y ago

Not sure I get this; who is this "counter party" you are referring to? My understanding was that the company doesn't actually buy shares on the open market when an employee vests RSUs or exercises options, but instead they either have a pool of shares waiting around (which they've never sold before), or they just mint new shares (and dilute existing investors). For the pool structure, sure, there's an opportunity cost (the company could instead sell those shares on the public market). But in neither case does the company have to go out and spend money to buy up shares.

GASCap 6y ago
In modern financial theory valuation = cost of replicating the position. One can approach that cost from how the company or the employee would replicate it. My point here is that it is much more expensive than just paying the employee cash due to the optionality and the financing costs associated with such.