Restricted Stock Units: The New Stock Option

Restricted stock units, also known as RSUs, are a form of compensation used by public companies to attract and retain top level performers/talent from moving to a competing firm or to take top talent away from a competing firm. This form of executive compensation has become very popular since the stock market crash of 2008. Corporate executives typically have three forms of income: salary, bonus, and RSUs and/or stock options. I have found while working with corporate executives the past 15 years that those who execute their RSUs in an effective manner typically create higher levels of wealth than those who do not sell and wait for higher prices.

So what is a Restricted Stock Unit? For this illustration I will use a local company in Indianapolis – Eli Lilly. An RSU is awarded by a company for performance at the time an employee is due for a raise or as part of an offer to attract executives to leave their company to join the new firm. An RSU is an award of company stock, restricted from being sold for a certain length of time. Typically the length of time is over the course of 4 years; employees gain the right to sell ¼ of the award on the year after what is called the grant date. So, if an employee receives 1000 shares on February 15, 2015, they are eligible to sell 250 shares on February 15, 2016 and 250 shares on each of the following years as long as they are employed by Eli Lilly.

For example, Susie Smith works for Eli Lilly. She has her review today and Eli Lilly grants Susie 1000 shares of Eli Lilly as part of her merit review and increase. She has a 4 year vesting on grant. The grant vests ¼ each year and fully vests in 4 years. Today, Eli Lilly is trading at $72 a share. Susie received an award worth $72,000 in today’s dollars but does not have access to receiving the award until a future date, called a vesting date. Eli Lilly wants Susie to stay working for them instead of taking her talents to another company. Susie must work the entire 4 years to receive the entire award. If the stock goes to 100, her grant is worth $100,000. If the stock drops to $50, the value of her RSU drops to $50,000. Many executives get awards like RSUs every year that they have been successful in executing their key initiatives for their companies. There are many variables to RSUs for wealth advisors to understand, but below are some general rules of thumb that I have experienced in helping executives who have this form of compensation:

When you have a vesting period, it is better to liquidate your grant versus holding your grant in hopes that the stock will increase in value over the years. If you sell your stock, you have the opportunity to diversify into something else, versus having “all your eggs in one basket”.

1) Fortunes and wealth have a higher probability of being lost to those that hold stock grants and options.

2) Deferring taxes to a later date has not proven to be a solid strategy.

3) Upper management is always bullish on your company. They have to be. They always expect the stock to go higher. You should not feel guilty if you sell stock in the company you work for. This is common in my experience; executives feeling they are doing something wrong. Consider stock options as part of your salary. I have a motto – family needs first!

4) If you sell your stock and it trends higher after the year it is sold, your job is more secure and the other RSUs that are not yet vested are more valuable. You did not lose anything by diversifying. If you are an executive that holds company options because it “used to be much higher”, you cannot control if it will get back to your desired price.

5)In my experience with clients who work for public companies, over the past 15 years the clients who sold their options are on average more wealthy today than those who did not sell (unless you work for a company like Google or Apple).

Being that we are in a bear market in US equities, many employees are coming up on vesting dates. Many corporate executives are dealing with losses in their option plans. It is still better to have an executed diversification strategy than a hold for high price strategy in today’s market.