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Google Lets Staff Auction Stock Options

12:07 pm on Dec 13, 2006 (gmt 0)

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Google plans to start an unorthodox stock options programme in April that will allow employees to sell their vested options in an online auction, the search giant announced late on Tuesday.

Google lets staff auction stock options [networks.silicon.com]

1:53 pm on Dec 13, 2006 (gmt 0)


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You've got to love the creativity that Google brings to even mundane aspects of their business.

While the move reduces the stake those selling options have in Google's performance, one presumes that those same individuals have four years of unvested options to keep them motivated.

2:40 pm on Dec 13, 2006 (gmt 0)

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It doesn't say were or who will do the auction so I wonder is this a test run for a new auction site as I for one would welcome anything that helps stem the tide to ebay and paypal.

One has to wonder why Google would give a whole year of free cc processing as this is millions of dollars out of their pocket as somebody has to pay the cost of this cash flow.

Trust me the banks aren't doing it for free. I now firmly believe Google is in the works for an auction now more than ever.

5:13 pm on Dec 13, 2006 (gmt 0)

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Naw, I doubt that Google will run the auction. And I wouldn't make too much of the word "auction" here. Every transacton on a stock exchange is an auction. And keep in mind that Google has never held an auction. (Adwords is NOT an auction, no matter how hard they try to make you believe that it is.)

The writer of the C¦Net article didn't quite understand what the innovation here is, so I will explain it:

When traded in an open market (as with listed or OTC options) options have two components to their value.

1. Inherent value. The difference between the strike price of the option (the price that must be paid for the underlying stock when the option is exercised) and the current market value of the stock.

2. Time value. You might want to think of this as the value of the option itself.

This is partly determined by the risk-free interest rate. When you buy an option, you are freed from having to tie money up in purchasing the actual stock. The money that you DIDN'T use to buy the stock can (in theory - of course, you may not have the money to start with...) can collect interest.

There is also a risk premium. An option limits your potential loss - you can't lose more than the price of the option if the stock price goes down. If you buy the actual stock, your potential loss is greater. This protection from loss has value, and thus we have the risk premium. Risk premium is mainly determined by the volatility of the underlying stock. The more volatile, the greater the risk premium.

There are other factors of lesser importance - for example, the value of future dividends. In this case, that's not a likely factor. (Google is not expected to pay dividends in the near future.)

The time value is worth - well, it's worth what people are willing to pay for it! But there are mathematical formula to rationally estimate time value. The most common of these is called the Black-Scholes formula or model.

An option has time value even if it has no inherent value. (Even if the current stock price is below the strike price of the option.)

Now, this is true for listed or OTC options (those that trade in some sort of market). One problem with employee stock options is that generally they cannot be transferred. So, the employee is not able to realize the time value of their options. They are only able to realize the inherent value, and then only at the time that the actually exercise the option.

You may have seen this issue in the financial news lately. U.S. public companies are being encouraged to value employee stock options using the Black-Scholes model. This affects reported financial results, as it fully recognizes the value of options granted to employees.

I gather the Google options will not trade on a public exchange, but will be traded to a favored few financial instututions. These options aren't suitable for public trading on an exchange, since they have varying terms and strike prices. They are going to have to trade on a restricted, OTC market.

Note also that these options have longer expiration dates than listed options. Most options have terms not exceeding a year. There are a smaller quantity of standard options that have expiration dates of 2 or 3 years. But these employee options can have expiration dates up to 10 years in the future.

Google's investment banker will "make a market" in the options, maintaining an order book listing the prices at which buyers and sellers are willing to make a transaction. This is the "auction" they are referring-to.

(If Google itself conducted this auction, it would both be highly irregular and a publicity ploy. This auction will probably be represented on a spreadsheet on one trader's computer. OK, the investment banker probably has a central database for OTC oddball options. They already have the system to trade this, in any case, and what would be the accomplishment if Google did it? Given the volume, this is something that would run on your grandmother's original IBM PC, with enough CPU time left to play Solataire all day. We're probably talking a couple of trades per day, if that.)

Google employees get to unlock the time value of their options. This is a bonus for the employee even if they would have otherwise exercised the option and acquired the stock. They can still buy the stock with the proceeds, and have money left over. (Or buy more stock.)

12:08 am on Dec 14, 2006 (gmt 0)

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just to add...
there is a market for this, it's called the derivative option market, the trade desk is typically a big wire house, they typically deal with large transactions IE 5 million dollars worth or more. maybe some small house is willing to do this for the entry chance.

also this might just be the right place to unload 20 to 30 million dollar position without causing to much problems ( big hedge funds like no-one to know there positions )

2:39 am on Dec 14, 2006 (gmt 0)

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eventually there's not much Goog can do.
I have stated months ago, that the gap between new and old employees will hurt google big time.

First, money matters so let's clear that one up. Sure the aura of working for goog, the technology and atmosphere are crucial, but so is money. Second, there is a limit on how much more google can pay its new engineers, a limit on how many options they can issue, and there's a limit on how high Goog's stock can go. In theory goog can even be valued at $10+ trillion but let's be honest here:
MSFT = $290 Billion PE of 24)
GE = $365 Billion (PE of 22)
Exxon = $450 Billion (PE of 12)

Goog ~ $150 Billion, with a PE of 60 and things are going GREAT; the Wall Street has not been disappointed yet with the earnings increase. I also realize that for fast growing companies a high PE is perfectly fine, but, Goog reached this valuation in 2-3 years so not a lot of people shared the wealth when compared to MSFT, DELL, WMT etc. etc. How much higher can it go for the new employees?

Lastly, let me remind you that a small slow down will cost Goog 20-30% in one day.

5:35 pm on Dec 14, 2006 (gmt 0)

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The whole point is to continue stimulating growth. When new employees come, there mindset shouldn't be "darn, the growth has already happened and I can't bank on." There attitude should be constantly asking how they can make things better so that there options are worth something in the future.

As for compensation, Google's compensation has gone up in an effort to continue to recruit the best. Even with the thrill of working for a search leader, you have to still have to deal with Cali costs of living, presuming you're in mountain view.


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