Employer Stock-Based Compensation: A Trap for the Unwary

In the last twelve months GE has shed roughly $140 billion in market capitalization—that’s approximately 2x the market capitalization lost in the Enron debacle, and more than the market-cap losses resulting from the Lehman Brothers and GM bankruptcies combined. That’s an ass-ton of light bulbs folks. I’m old enough to remember a time when GE stock was known to be rock-solid stable. As reliable as, you know, Apple stock seems today. (Smile.)

An article in the Wall Street Journal this week discussed how the massive stock-value losses have adversely impacted GE retirees. And not just any retirees: of course we’re talking specifically about those that had invested heavily in GE stock as part (or all) of their retirement plan. The article describes how the GE stock bought by these retirees through employee stock purchase plans (ESPPs) over the course of years (or decades) of employment has dropped precipitously in value, and thus endangered the retirement plans of these would-be tasters of freedom. Oh, and just to sprinkle a little bit of salt in the wound, the piece also offers up that the GE pension plan is in a bit of trouble: the pension liability is currently equal to 71.4% of GE’s total assets, and is described as one of the “worst-funded” corporate pensions in America. The article quotes a couple of individuals affected by the sh!t-storm which is the state of GE’s stock in the wake of Emperor Immelt’s departure:

“We never thought GE would do this to us … We believed they would do their best to take care of us.”

“He [the retiree] figured the company was just about invincible, which made the fall in its stock price devastating.”

And what’s so odd is that all this damage to the underlying business was incurred on the watch of a CEO that was so damn good and so critical to the success of the company that he had an empty spare jet follow him around whenever he traveled . . . just in case the jet he was in had any mechanical trouble that could delay him for a bit. (Thought: recall that Peter Lynch bit about looking at how many fancy dining rooms, pieces of artwork, and corporate jets a company had in evaluating whether you should invest? Seems spot-on here.)

I’ll Take the Cash Please

When I was at the fancy-pants law firm I didn’t receive any stock-based incentive or deferred compensation. No stock options. No ESPP. Not even a 401(k) match paid in corporate-stock currency. Just cash. Cold, hard, train-riding cash. Had a good year selling your life in six-minute increments? Great, here’s a big-ass bucket of more cash.

Initially I lamented the absence of corporate perks that some of my clients’ employees received, but eventually I realized that being paid straight-up cash with no strings attached was a wonderful thing. It was mine . . . right now. It wasn’t subject to forfeiture if I did something crazy—like leaving to pursue freedom. Or for any other reason. And because I didn’t have a whole crap-ton of comp that I had supposedly already “earned” tied up in an arrangement where I could lose it if I was fired, I didn’t have a corporate over-lord to whom I was obligated to demonstrate my unrelenting fidelity by perpetually holding (i.e., not selling) the shares of stock that had fully vested. (Note: Lawyers generally don’t have allegiance to any institution anyway; their loyalty is to the cash that pays the private school tuition and the huge mortgage on the second home in Aspen.)

Oh, and here’s the best part: because I had all this cash coming in that I wasn’t spending on a Mercedes and other stupid crap to show how important I was, I had to learn how to invest it. And not just in the tax-deferred accounts—I had to learn how to manage the after-tax dollars too. Frugality was in my DNA, but having to learn how to invest cash at an early stage of my career gave me a chance to head-off any bad financial habits before they took root, and to see the money start accumulating and growing while my peers were still struggling to put a dent in student loans.

The Public-Company Employer: Who’s Your Daddy?

When I moved in-house to the Fortune 100 corporate employer after a decade-plus at the law firm I was quickly introduced to a much different environment. Nearly every piece of compensation (excluding free cash of course) had some element of incentivizing corporate stock ownership . . . and continued employment by the company.

OK, so, the idea behind stock-based incentive compensation makes sense: give Working Joe some skin in the game; a reason to want the best for the corporate bottom-line, and foster loyalty and longevity of employment in the process. And this arrangement can lead to spectacularly good results for Working Joes. In fact, some of the folks working for me at the company (and who had been there for decades by the time I arrived) were driving to and from the entrapment chamber every day in luxury autos, and were commonly known to have “made it big” by leveraging the incentive programs and utilizing corporate financing offers to go all-in on company equity. Needless to say, this company’s stock had done very well in the preceding decades.

But this good-in-theory idea becomes a dangerous trap when extended too far (like most good-in-theory ideas). At my corporate gig more than 60% of my annual compensation package came in the form of deferred stock that would vest over a period of years. And the 401(k) offered a juiced-up matching amount for money that I held in corporate stock inside the plan. Very early in my tenure I was at lunch with a colleague who shared an interest in personal finance matters. When he said something that implied a high concentration in the company’s stock, I asked him how much of his portfolio it comprised. “Probably close to 90%.” And not of his portfolio; of his net worth. Gulp. Being the diplomatic and try-not-to-offend kind of guy that I am, I promptly announced that I would run like hell from any concentration of a single issuer that approached even 5% of my portfolio—especially if that issuer was the same one that sent me my paychecks. The conversation changed very quickly.

Trapped In Work

The net result of all this restricted stock-based compensation was to effectively trap employees in the company, and subject them to an absurdly high level of portfolio risk. There was a pervasive implied peer-pressure to never sell company stock—you know, to prove that you are a real company-man. And even if you were bold enough to decide to diversify, you likely had 6 to 7 years worth of compensation tied up in restricted (i.e., un-vested) stock that would perpetually be rolling forward until you retired at 65 (one lot vests at the same time that the next restricted lot is granted). And if you left the company you would forfeit all of that restricted stock as well as the fairly lucrative defined-benefit pension benefits that would cease to accrue (but the whispers in the halls eventually proved prophetic when the company abruptly shut down the traditional defined-benefit plan accruals . . . which really sucks if you’ve been there 15 years and stayed because you planned to accrue 30 years of benefits to fund retirement). I had multiple conversations that included something along the lines of: “I’d really like to consider this new opportunity but I can’t . . . .” Translation: trapped in work.

Plan Your Escape From Day One

I knew going in to the corporate gig that I would have to develop a plan to manage this environment. So I decided to announce early and often to anyone that may have cared: I’m selling every share the moment it vests. “I’m a crazy hard-core indexer” I would say. “Can’t sleep at night without total diversification.” I got some confused stares and some evil-eye looks at first, but soon it was “just something that Joe Freedom guy does . . . he’s a newbie, he doesn’t get it like we do. High five!” But I never had to have an argument with the C-level about why I was selling. It would have been much more difficult if I had let large sums accumulate and then tried to sell. By then I would have already been labeled a company-man.

Until It’s Yours For Reals, It Isn’t Yours

I also employed a Jedi-mind trick (on myself, which is easier): I didn’t view the un-vested stock awards as mine. Because in reality they weren’t. If someone on the bridge decided they didn’t like the cut of that Joe Freedom guy’s jib and fired me, that honey pot would have vanished. Poof. Like that. So I viewed those dollars as just numbers on a page rather than an account that I owned (even though it was presented to me as an account that I owned of course). When I left after 3 years by declaring myself officially freed from bondage I did have to “forfeit” a big slug of deferred compensation. But it was cool because I had never viewed it as “mine.” And every year that I stayed that number was only going to get bigger. I told myself at the start to avoid fixating on that sexy deferred comp figure so that it wouldn’t cloud my judgment later on. This seemed to work. But I also realized that as the number grew insanely large it may have become too much to bear; the mind-trick may have failed. Two more years in the entrapment chamber may have led to an additional 25 to boot. And if that had happened, who, I would ask, would be writing these highly sporadic blog entries here at Trapped In Work right now?

ESPPs: Avoid Like the Plague (or Bitcoin)

Employees were offered the “perk” of buying even more company stock at a 6% discount to the current market price. While at first blush this may appear to offer a nice arbitrage opportunity, you had to hold the shares for a minimum of three years. As we’re all being reminded right now by the undulating market, a stock price can move 6% in 6 minutes, wiping out any assumed arbitrage value long before the expiration of the minimum holding period. This is the only ESPP that I have looked at in any detail, so I won’t assert that all plans are without potential arbitrage value. (Note: this holding-period feature is mandated to some extent by tax laws, so I imagine that it is present in many ESPPs, or at least those that don’t want to create taxable income for the employee at the time of purchase). But in any event, unless you are offered free money in the form of immediately harvestable arbitrage value, it would make very little sense to take any of your discretionary investment funds and voluntarily buy more company stock when you already have significant sums tied up and that you are precluded from diversifying.

Push Back

Here at TIW we’re committed to alerting the Working Joe public of any and all threats to their individual (money-related) freedom—anything that could trap them in work against their conscious will. The unfortunate and Black-Swan-style GE saga of cratering stock price and under-funded pension plan appears to be such a threat. If this can happen to GE, it can happen to any company.

Your corporate employer’s raison d’être is not to “take care of you” in retirement. Its purpose is to maximize return for shareholders right now (it should be to maximize return for shareholders over the long-term, but while this mantra is often repeated, I fear it is purely lip service and not the driving force behind corporate strategy decisions). And more increasingly the corporate purpose is to stroke the ego and feather the nest of the top executives (Exhibit A: Mr. Immelt. Methinks his retirement isn’t suffering from any of this crap).

So stand up to peer pressure (isn’t it funny how most of the principles we teach our kids are applicable through all stages of life?). Don’t go along with the crowd that’s just “trying out” the new designer drug . . . I mean, keeping all of their employer stock “for now” because the boss might notice if they didn’t. Before you realize it you will have developed a really bad habit that is going to be a bitch to break.

Think different, go against the grain, and do what you have to do—without apology—to protect your future freedom.