The tax treatment of employee stock options : generous to a fault

In the 2000 budgets, both the federal and Ontario governments introduced changes to the tax treatment of employee stock options for the explicit purpose of making their tax treatment in Canada similar to or more favourable than that in the United States. The federal budget added a deferral, similar to that currently applicable to options granted by Canadian-controlled private corporations, for up to $100,000 per year of public company stock options. The Ontario budget introduced an exemption from tax for employees involved in research and development on the first $100,000 per year of employee benefits arising on the exercise of qualified stock options or on eligible capital gains arising from the sale of shares acquired by the exercise of eligible stock options. These proposals reflect the apparent acceptance by the two governments that there is a “brain drain” from Canada to the United States of knowledge workers in the “new” economy and that reductions in Canadian taxes should stem this drain. In the author’s view, the tax treatment of employee stock options, even without these changes, is overly generous. Both the federal and provincial proposals ignore the fact that most employee stock options are taxed more favourably in Canada than in the United States in any event. In particular, most employee stock option benefits in Canada are taxed at capital gains tax rates, whereas in the United States most are taxed at full rates. While the US Internal Revenue Code does provide capital gains tax treatment for certain employee stock option benefits, a number of preconditions must be met. Most important, the shares acquired pursuant to the options must be held for a minimum of one year after the option is exercised. In addition, there are monetary limits on the amount of options that qualify for capital gains treatment. In Canada, there are generally no holding period requirements or monetary limits that apply in order for the option holder to benefit from capital gains tax rates. Empirical evidence indicates that the vast majority of employees in the United States exercise their options and immediately sell the shares acquired. These “cashless exercises” do not benefit from capital gains treatment in the United States, whereas similar cashless exercises in Canada generally do. This empirical evidence suggests not only that the 2000 budget proposals are unwarranted, but also that the existing treatment of employee stock options in Canada is already more generous than that in the United States. This article begins with a theoretical “benchmark” for the taxation of employee stock options. The author suggests that employee stock options should be treated in the same manner as other income from employment. In theory, the value of the benefit should be included in income when the option is granted or vests. However, owing to the practical difficulty of valuing employee stock options, the theoretical benchmark proposed is that the value of the benefit (the difference between the fair market value of the shares acquired and the strike price under the option) be taxed when the shares are acquired, and the employer be entitled to a corresponding deduction. The employee stock option rules in Canada and the United States are then compared and contrasted with each other and the benchmark treatment. The article then examines the arguments that have been made for favourable treatment of employee stock options. Included in this critique is a review of the recent empirical work on the Canadian brain drain. Empirical studies suggest that the brain drain—if it exists at all—is small and that, despite what many newspapers and right-wing think-tanks would have us believe, lower taxes in the United States are not the cause. One study, concluding that taxes do have an effect on migration, suggests that even if Canada adopted a tax system identical to that in the United States, the brain drain would be reduced by a mere 10 percent. Indeed, even if Canada eliminated income tax altogether, it would not stop the brain drain. If governments here want to spend money in order to stem the brain drain, they should focus on other areas. For example, Canada produces fewer university graduates in the fields of mathematics, sciences, and engineering than any other G7 country except Italy. The short supply of university graduates in these fields, the apparent loss of top-calibre academics to US
universities, and the consequent lower levels of university research in these areas (an important spawning ground for new ideas in the “new” knowledge-based economy) suggest that Canada may be better served by devoting more resources to its university institutions, particularly in post-graduate programs, rather than continuing the current trend of budget cuts that universities have endured and may further endure if taxes are reduced.
As far as employee stock options are concerned, if Canada does want to look to the United States for guidance on tax reform (which it seems to do with increasing frequency of late), it should adopt the US rules applicable to nonstatutory options, which are close to the proposed benchmark treatment. In the absence of preferential tax treatment, employee stock options would still be included in compensation packages provided that there were sound business reasons for their use. No persuasive evidence has been put forward that the use of stock options, in the absence of tax incentives, is suboptimal. Indeed, the US experience suggests quite the opposite.

Non executive employee stock options and corporate innovation

We provide empirical evidence on the positive effect of non-executive employee stock options on corporate innovation. The positive effect is more pronounced when employees are more important for innovation, when free-riding among employees is weaker, when options are granted broadly to most employees, when the average expiration period of options is longer, and when employee stock ownership is lower. Further analysis reveals that employee stock options foster innovation mainly through the risk-taking incentive, rather than the performance-based incentive created by stock options.

The employee share ownership plan: what value has it for Australia?

The Australian government is currently committed to the goal of increasing organisational participation in employee share ownership plans (ESOP) from 4% of all companies to 11% by 2009. The Nelson Report into ESOPs commissioned by the Honourable Brendan Nelson highlighted the lack of comprehensive information on the nature and extent of ESO plans in Australia. ” (Nelson 2000). This paper places the program in context by reviewing overseas experiences and considers the viewpoints of both employers and employees. The preliminary investigation concludes by highlighting the need for further thorough research before success for all types of businesses can be confidently predicted. ”

The employee share ownership plan : data and implications for Australian businesses

The Australian government is currently committed to the goal of increasing organisational participation in employee share ownership plans (ESOP) from 4% of all companies to 11% by 2009. The Nelson Report into ESOPs commissioned by the Honourable Brendan Nelson highlighted the lack of comprehensive information on the nature and extent of ESO plans in Australia. This paper places the program in context by reviewing overseas experiences and considers the viewpoints of both employers and employees. The preliminary investigation concludes by highlighting the need for further thorough research before success for all types of businesses can be confidently predicted.

Strategic vote manipulation in a simple democracy

In both the Employee Stock Ownership Plan (ESOP) and employee buyouts, the common and crucial phenomenon is that some workers have two sources of income, namely wages and shares of profit. We analyze that phenomenon in an economy where workers are nonunionized and wages are determined by voting. If the employers sell a certain amount of shares of the capital stock to some non-risk-loving workers, these workers vote for the lowest possible wage along with the employers. As a result, all workers become equally worse off because of the competition among workers to buy those shares.

A review of stock enhancement practices in the inland water fisheries of Asia

Inland fisheries contribute only about ten percent to global fish production. Asia is the leading producer of inland fish, accounting for over 80 percent of the total production. Until recently, the inland fisheries sector had taken back stage in fisheries development plans, particularly so, given the emphasis being placed on aquaculture development throughout the world, including Asia. This report evaluates the inland fishery practices in a number of Asian countries according to habitat type, role in overall foodfish supplies and development trends. Special emphasis is laid on stock enhancement in inland fisheries in Asia, and only those fisheries in which some form of stock enhancement is practised are considered in this report.

In Asia, inland fisheries are mostly rural, artisanal activities catering to rural populations and providing an affordable source of animal protein, employment and household income. Stock enhancement is an integral component of many inland fisheries. With recent developments in
artificial propagation techniques for fast-growing and desirable fish species and the consequent increased availability of seed stock, such activities are beginning to affect inland fishery production in most Asian countries. Indeed, new avenues of production such as culture-based fisheries are increasingly adopted and seen as a way forward in most countries. Inland fishery activities also have a distinct advantage in that their development is usually less resource intensive than is aquaculture.

The economic viability of stock enhancement of large lacustrine waterbodies and rivers has not been demonstrated in any of the Asian countries, the fisheries of such waterbodies being dependent on naturally recruited stocks. The most successful stock enhancements in Asia are in floodplain beels and oxbow lakes in Bangladesh where the use of small waterbodies that are not capable of supporting natural fisheries has led to culture-based fisheries having stock and recapture rates that are very high. Culture-based fisheries are not resource intensive and are community-based activities. However, their success requires major institutional changes, and these are affected by national and local governments. In general, they can be considered to have the greatest potential for further development.

A major concern related to stock enhancements in inland waters is their possible effects on biodiversity. This is for two reasons: firstly, most countries depend wholly or partially on exotic species for stock enhancement and secondly, freshwater fishes are known to be among the most threatened of vertebrates. Major studies should be undertaken to evaluate the current situation so that remedial steps can be taken, if needed, without causing serious harm to some of the stock enhancement practices that are gaining momentum.

The cost of granting executive stock options with strike prices adjusted by the cost of capital

Purpose – The purpose of this paper is to estimate the cost of granting executive stocks with strike prices adjusted by the cost of capital.

Design/methodology/approach – In the paper a Monte Carlo simulation approach developed in Longstaff and Schwartz is used in conjunction with the subjective valuation model developed in Ingersoll to value these executive stock options that are subject to performance hurdles.

Findings – The paper finds that standard European Black-Scholes-Merton option values overstate the true cost to the firm of granting these executive stock options. The option values also decrease with a higher dividend yield, a higher performance hurdle, a longer vesting period, and a shorter maturity.

Research limitations/implications – While the study in the paper is limited to the valuation of executive options, the methodology can be used to study incentive effects of executive stock options that have a performance hurdle.

Practical implications – The approach used in this paper to estimate the cost of granting executive stock options is a clear improvement over standard European option pricing approaches that often result in biased estimates.

Originality/value – This paper presents a first attempt to integrate the Ingersoll utility-theoretic model and the Longstaff and Schwartz least squares Monte Carlo algorithm to estimate the subjective value and the objective cost of executive stock options with a performance hurdle. This valuation approach will be useful in the study of other types of executive compensation.

Physical activity promotion for male factory workers : a realistic option?

Issue addressed: Worksites are a promising setting for health promotion initiatives. While there is an accumulated body of evidence indicating favourable health and cost outcomes, there have been difficulties identified in recruiting and influencing blue- collar workers. This descriptive study aimed to identify specific opportunities and barriers which may impact upon physical activity options at work for male blue-collar factory workers.

Methods: Fifteen manager interviews and worksite observations, and eight employee group discussions were conducted in manufacturing industry worksites.

Results: Several key barriers emerged which limit opportunities for blue-collar employees to participate in physical activity at work: time constraints; limited facilities; and lack of interest from management to facilitate physical activity due to limited resources and concerns about safety issues. Potential opportunities included the presence of change rooms, showers, outdoor areas suitable for physical activity, nearby parks and local fitness facilities, and occupational health and safety committees.

Conclusions: Increasing opportunities for workers to be active at work did not emerge as a priority of managers who may need to be convinced that allocating time and resources to physical activity is a wise investment and that workers need an environment that both supports and encourages participation in physical activity. The role of physical activity in relation to injury prevention and potential reductions in Workcover premiums is worthy of further investigation.

So what? While worksite physical activity promotion is a national health objective, there are numerous actual and perceived barriers to initiatives directed at factory workers. Rather than offering specific programs, it may be more productive to address work practices and environmental and regulatory barriers through established occupational health and safety channels. Information and education strategies to change the attitudes and beliefs of management and workers about these issues, as well as about the health benefits of physical activity, may also be helpful.