I recently attended an industry event where practitioners debated whether it is still a good idea to grant Incentive Stock Options (“ISOs”). The arguments on both sides had some merit, but the one that soundest the strongest was, in my opinion, the weakest. Those that spoke for the continued and even expanded use of ISOs mentioned the incredible benefits they offer for employees. ISOs offer the ability for employees to avoid nearly all of the ordinary income and associated tax withholding that are required when using Non-Qualified Stock Options (“NQSOs”) or restricted stock, RSUs, Phantom Stock, SARs and just about every other compensation instrument. It was argued that a company making the effort to offer stock options and NOT to offer ISOs simply didn’t make sense.
Those who argued against ISOs discussed a wide array of issues. ISOs are more difficult to administer. They provide less tax deduction to the company. There are potential finance and accounting issues that may make them worse than NQSOs. Seemingly the strongest argument against ISOs was the fact that most employees disqualify their grants from preferential tax treatment. So, why offer employees something they don't take advantage of?
The last issue, the fact that 85-95% of employees disqualify their ISOs when they exercise is the most vexing. Taking something good away simply because it is not used optimally seems lazy and a bit simple-minded. It is sort of like arguing that we should get rid of voting because most eligible voters didn't vote in the mid-term elections.
It seems to me the blame is being placed on the wrong people. This is kind of true about nearly every type of compensation. The complaint is too often that people don't value what the company is offering, rather than admitting the truth. Most companies are pretty lazy when it comes to ensuring people are both informed and excited about the potential of the opportunity being offered.
Is your approach to employee education passionate? Do you spend as much effort and money on ensuring understanding as you do on analyzing survey data and setting pay levels? We claim we use the tools beyond base pay to help motivate, retain and engage our staff. But, do we really do everything we can to get the most out of those tools?
Don't structure your compensation programs based on what you think your employee value. Teach your employees to value the tools you know are best for them and the company. The cost of a great communication program is usually less than the lost value of a single poorly communicated incentive award granted to a mid-level employee. Rather than waste those compensation dollars, imagine if you spent the little bit extra in time, money and effort to squeeze every bit of value out of every compensation element.
In other words, before you decide to get rid of something valuable like ISOs, first make sure that you have truly done everything possible to allow employees to perceive and actualize the real value of the awards. It might not be your employees who aren’t valuing what you have to offer. It may be you.