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Intel and Airbnb recently disclosed restricted stock unit (RSU) grants to CEOs that vest based on meeting aggressive stock price hurdles ranging from 3x (Intel) to about 10x (Airbnb). It is surprising to note that these companies set very aggressive stock price hurdles but decided to use RSUs and not stock options under these grants.
Generally, when selecting between RSUs and stock options, it makes sense to use RSUs when a company is trying to manage inherent risk with stock options. Stock options are not attractive if stock price does not grow in a meaningful way after the grant date. As a background, most stock options vest based on lapse of time and most RSUs vest based on lapse of time and/or satisfaction of performance conditions (e.g., earnings-per-share [EPS] goals, relative stock performance, etc.).
If a company plans to give long-term incentives that vest based on aggressive stock price hurdles, it should seriously consider using stock options instead of RSUs. Otherwise, from the recipients’ point of views, they are leaving a lot of value on the table. Let’s use semiconductor giant Intel as an example.
- Grant value: $20 million
- Assumed grant date stock price: $50
- Number of RSUs granted: 400,000 ($20 M/$50)
- RSUs vest at 3x grant date price (i.e., $150) during the next five years
- Projected payout if the stock price hurdle is met: $60 million (400,000 RSUs x $150) – see technical notes below
- Projected payout if stock options were used:
- Intel is using the 30-day average price to convert $20M into number of RSUs
- The accounting cost of RSUs is likely to be different than $20M due to accounting rules. Intel is required to use a Monte Carlo model to estimate the accounting cost. The accounting cost is likely to be more than $20 million.
- Generally, companies use a Monte Carlo model to determine the accounting cost of stock options when options vest based on stock price hurdles. The same accounting cost is also used to determine the number of stock options in this example. The exchange ratio used earlier provides a reasonable range for our analysis to estimate the number of stock options Intel would have granted if this was a stock option grant.
- Dividends on RSU have been excluded from the analysis to keep it simple, but dividends are not going to impact conclusions.
The analysis shows that Intel’s CEO could have earned significantly more for exactly the same performance if he would have received stock options instead of RSUs. I do not know Intel’s reasoning for using RSUs instead of stock options, but let’s discuss potential reasons along with my thoughts:
- Cost of RSUs versus stock options. Both awards cost the same from accounting cost (P&L point of view), but stock options are more dilutive than RSUs. Dilution is not a good reason to forgo stock options because higher dilution cost also provides higher benefits (compensation) to the CEO and an additional dilution level is negligible in this case (less than 0.01%).
- Limit the level of compensation. I doubt this is a valid reason considering Intel’s overall compensation package (more than $100M at grant date) and potential future value of these awards. Generally, companies look at total compensation value as of grant date and not as of payment or vesting date.
- Limit risk taking. Stock options could encourage imprudent risk-taking activities. I think this rationale is not valid considering that the RSU grant vests only if the stock price reaches $150.
- Philosophical reasons. It is difficult to imagine any philosophical reasons due to the design of the RSU program and overall compensation package, including award types and sizes.
We get similar results when reviewing Airbnb data. For example, Airbnb’s CEO vest is 1.2 million shares if the company’s stock price reaches $485. (The stock price was about $50 at the time of grant.) The projected Airbnb payout if stock options were used instead of RSUs:
Interesting note: In the case of Airbnb, the loss of value is society’s loss because the CEO intends to donate proceeds from this award.
I understand that the Intel and Airbnb RSU values are large numbers even under the current design. I am not suggesting that the companies should have paid more compensation. My main point is that RSU is an inefficient vehicle considering the performance level required to earn these shares. The conclusions in this article apply at all employee levels, not just CEOs. If a company expects significant growth (e.g., in case of a pre-IPO company) in stock price, it should consider granting stock options and not RSUs. The table below provides the sample future stock price growth required to make stock options more attractive than RSUs.
In conclusion, companies should consider using stock options and not RSUs when they expect significant stock price growth. Similarly, when a company ties long-term incentive vesting to aggressive stock price hurdles, stock options should be the preferred vehicle.
About the Author
Anil Agarwal is a multifaceted total rewards professional with broad industry and consulting experience.