What Should You Do with Your Employee Stock?

MARK RIEPE: As I'm recording this, the U.S. labor market is on a bit of run. with hundreds of thousands of jobs created in the last few months.

There's a lot that goes into the decision of taking a new job. The benefits package is one example. 

Many jobs offer health insurance and paid time off for vacations, but some employers go further. offering non-cash incentives like travel benefits, paid sabbaticals, office perks, workplace flexibility, paid time off to volunteer, and even pet insurance. Ben & Jerry's employees get to take home three pints of ice cream per day.

All those items are nice, and in the case of health insurance, especially important, but you can't pay the rent or the mortgage with them. That's where compensation comes into play. By that I mean how much you get paid.

I'm Mark Riepe, and I head up the Schwab Center for Financial Research, and this is Financial Decoder, an original podcast from Charles Schwab. It's a show about financial decisions and the cognitive and emotional biases that can cloud our judgment.

There was a time when pay was simple.

I'm looking at a printout of the Code of Hammurabi. He was the sixth king of the first Babylonian dynasty and ruled from 2130 to 2088 B.C.,[1]  so that's about 4,000 years ago, in present-day Iraq. It's essentially a legal code that the king put together, and I'm looking at rule #257. It says, "If a man hires a field laborer, he shall pay him eight gur of grain per year." According to Britannica.com, a gur (that's spelled G-U-R) is a unit of volume that equals 80 U.S. gallons.

So imagine that you have a one-gallon container. Your wage is 640 of those filled with grain each year, or a little over 12 gallons per week.

And just so there's no misunderstanding—that's not just the minimum wage; it's also the maximum wage. But hey, it could be worse.

According to rule #258, "If a man hires a herdsman, he shall pay him six gur of grain per year."

Maybe being a herdsman is easier or requires less skill than being a field laborer. Who knows? But what I do know is that in today's labor market, we use financial compensation to pay employees, but not all compensation takes the form of a cash salary or bonus.

Today, many startups and most of the companies on the Fortune 500 list allow their employees to take ownership in the company through stock awards, employee stock purchase plans, stock options, or some other form of equity compensation.

And equity compensation matters. A Schwab survey from 2020 showed that 37% of participants considered equity compensation to be one of the main reasons they took their job, with over half of Millennials attributing it as a deciding factor.

Now the mission of this podcast is to help educate listeners about financial decision- making, and there's a huge opportunity in this space.

Despite this boom of employee ownership offerings, employee education and familiarity around these offerings appears to be falling behind. In that same survey, most employees weren't sure how specific equity compensation types fit into their portfolio. 

And that's understandable because there's a lot to take in. The details can seem like a confusing swarm of acronyms, tax issues, and timing decisions that can obscure the benefits of a potential windfall.

Here to help bring clarity to this topic is Stacie Sands, a director on Schwab's Stock Plan Services team and a Certified Equity Professional.

Stacie has more than twenty years of experience in the financial services industry, with just over a dozen of those years spent here at Schwab, where she now leads service groups providing support to employer-sponsored benefit plans.

MARK: Stacie, thanks for being on the program today.

STACIE SANDS: Thank you for having me. Very excited. 

MARK: We're going to kind of kick things off talking a little bit about all things equity compensation. But maybe before we get to that, you work in stock plan services. How did you find yourself getting to that particular point in your career? 

STACIE: Well, you know, a lot of us in equity compensation, otherwise known as stock plan services, find ourselves falling here. I did that, but with great joy. About 25 years ago, I started in the mutual fund industry as a phone representative. I moved through that job and found myself in retirement plan services. I loved the niche part of that in the 401(k) space. The ERISA rules really spoke to my rules soul. And then I found myself at Schwab, and equity compensation was my new challenge after about 15 years in 401(k). And I've been here for the last 12. 

MARK: OK, we have set a Financial Decoder record, the first person to say that ERISA rules really spoke to somebody. So that is fantastic. Stacie, before we get into some of the specifics of equity compensation and really employee compensation in general, can you give us kind of a quick history of how we got to this point? Other than paycheck, what have been the big drivers and changes in those drivers of employee compensation over time?

STACIE: Yeah, sure. You know, I came into the industry about 25 years ago. Probably the reason I was involved in 401(k) is that was a big piece of the pie. 401(k)s were very big about 25 years ago. Other things that still existed were defined-benefit plans and profit-sharing plans. Those were very common. Those were all devised as retention and retain employees for the same purpose that equity comp is. 

Over time, defined-benefit plans, I like to say, have gone the way of the dodo. They're very cumbersome and costly for companies to maintain, and they have really kind of stepped away from those. And while the 401(k) still exists, profit sharings are also difficult to maintain because they are based on the profit of the company. 

So we have seen a shift to equity compensation and the fact, if you're a public company, you have some things at your disposal being that stock of your company that you can issue. In the last 10 years or so, that's really moved towards the restricted stock unit—where you might hear it referred to as an RSU for short—type of grant. 

There's many reasons for that, but just in general, they resonate better with your average broad-based employee, from an RSU perspective, because those are very tangible, hard stock deposits that they get on a schedule. They can plan on it. They can choose to retain it in their investment portfolio and potentially grow that wealth, or they can choose to get cash out of that at the time of deposit, whereas options have a little bit more of a flexibility to them and a nuance to them that may not necessarily be for the non-executive. 

MARK: Are those the kind of the primary categories, if you look at a really high level, are those are primary categories of equity comp? We've got, you know, equity, and then we've got options. Is that it, or are there bigger categories that really matter on a day-to-day basis? 

STACIE: Those are two big categories as far as when an employer grants something to an employee. I would say the next big item would be ESPP plans, or employee stock purchase plans. Those are voluntary choice on an employee's part, and those have a tendency to steep into a culture employee ownership. So that's a completely different version of it. It's more voluntary as opposed to being granted to you, but it is definitely something that's important in the landscape. 

MARK: Restricted stock units, the RSUs you were talking about, those are becoming more popular. Options are becoming less popular. What do you think is driving that? 

STACIE: Probably the volatility of the market is what's driving that. When you grant an option to be exercised at a future time, it's hard to value that. There's no real guarantee that's going to be worth something that much more to your employee in time. And it's scary. They have a lot more rules. They have more tax consequences. And so employees tend to shy away from them even when they are issued, if they're not an executive, for example. 

Restricted stock really resonates with a broad-based employee. When I keep saying "broad-based," I mean just your person who's typically not in your C-suite. Your average employee that would engage with you on a day-to-day basis in any business. That makes more sense to them. They're hard, realistic terms that can be understood. The taxation is just the same as your paycheck unless there's a long-term holding of that stock. And there's ability to get cash out of it without being scared of what happens, if I get that cash, to my taxes. 

MARK: One of the things that we periodically try to do, we try to just kind of make sense of some of the jargon that gets thrown into financial services. I don't think equity compensation is any different. If people learn anything from this episode, they should walk away understanding two terms, exercise and vest. So can you give us the kind of 101 version of what those two terms mean? 

STACIE: Sure. When you receive an option, you are receiving the right to exercise the option to buy stock at a certain price. 

So when you receive that stock—say they say, "We'll give you 10 shares at $10." As it vests, you have the right to buy those shares at $10, whether the market's at $100 or $50 or $10.50. You have the right to buy those and exercise your right to buy at a specific price. When we're talking about vest, it's a little different. 

If an employee is granted a restricted stock unit, say for $10,000, and it vests over four years, you're likely to get approximately or likely 25% each of those four years. That stock may be worth more as those years go on. That stock may be worth less because you're receiving shares. So it all becomes what those shares are valued on that day that vests. 

Often when people come into the equity space, and they receive their first grant and they get a little confused about that, I'll typically, because of where I started, will refer them back to when you have a 401(k) and your employer contributes for you, that money vests over time. People tend to understand that particular analogy because they're used to seeing their 401(k) more often, and they're used to seeing my employer contributions are 25 or 50 or 75 or 100% vested. 

It's really, when do I get all that money? But the difference is, is that in a stock grant, you're going to get it over time. So just because it's not fully vested doesn't mean you're not going to get anything. Each year you're going to get a little bit. 

MARK: And when you vest in an option, what you're really getting is the right to make a decision, as you described. Whereas when you vest in a restricted stock unit, that's yours, right? You get to keep it.

STACIE: Right. You get the stock when you vest. When you get an option and you vest, you get the right to make a decision. 

MARK: So I think, you know, kind of the bottom line there is before you start making decisions about what to do with these things, you've got to have some basic level of understanding about how they work. Is that fair to say? 

STACIE: That is absolutely fair to say, yes. 

MARK: And so how do you think about that when, for example, considering going to another job, given that maybe you've gotten a grant in the past, maybe some have vested, maybe some haven't vested yet. How do you think about that? 

STACIE: Yeah, I mean, these grants are given to you as a retention tool in most cases. They give them to you over three, four years because they want you to stay with the company. And so it needs to have some value to you. 

If you leave after two years, and say you have two, we call them tranches, left that have not vested, then you need to say, what is the value of that? If I'm going to a new job, am I truly walking away from money on the table in the next two years that I can't make up from this new job? Or is it not enough to make that difference? 

Obviously, a personal financial decision, but that's where you have to weigh what's the balance for you. What's the new offer look like, and what's the offer you're leaving on the table? 

MARK: Another kind of common, let's maybe call it a crossroads, happens when an employee gets to a vesting date. And if they've got options, they've got to decide, should I exercise and sell? Should I exercise and hold? Same thing with restricted stock units. Should I hang on to these? Should I sell enough to pay the taxes that are due? That's a lot to take in. How do you navigate that decision? 

STACIE: Yeah, options are a very emotional financial decision. And one we always recommend you have a financial counselor to review with you because when those vest, they may or may not be in the money. Meaning they were granted at a certain price. What is the stock price today? If they were granted at $10, and the stock price today is 100, you have a right to buy the number of shares you were granted at $10. That's an immediate gain. That's also a potentially very scary tax bill, depending on what that cost is, right? That is something that happens a lot with options. 

People get very scared of those taxes and that spread when they had that big gain. And so people tend to shy away from them. And honestly, people will let them sit. They don't know what to do with them. 

So financial help is always recommended with those. And choosing where that spread and that gain would fit into your personal financial portfolio and the risk tolerance that you have. 

MARK: What are some of the other kind of tax issues between restricted stock units and options? 

STACIE: Yeah, restricted stock units, there's always tax consequence because that is compensation. It is W-2 money that you are receiving, and you are due payroll tax on, but it's an immediate thing in that moment. So it's kind of a different way of getting a bonus. I've never seen anybody shy away when their employer says, "I'm going to give you $10,000 in cash and add it to your check." They know that taxes are just going to come out of that. And that's exactly what happens with an RSU vest. That happens at the moment, at the vest. So you can see what's coming over your vesting schedule. 

Now, if you choose to hold those shares, it is potential in the future that you may have a gain, and you may have to deal with short-term or long-term gains in your investment account. But if you don't want to do that, you know the taxable implication right then and there. 

With options, it's fairly rare that you're going to, unless you've had a huge gain in what you were given, going to exercise them right at vest. Options are about 10 years long when they're granted typically. You've got a long time to make that decision. They're looked at as wealth generators, so you do want them to give you wealth. 

So if you choose to exercise and sell, in the moment, that means you're trying to generate cash and will have a fairly immediate tax bill, which can include gains and income. If you exercise and hold, that's typically a pretty bullish position. You're betting that I'm going to buy the stock at this price, it's a little bit lower, because I see this stock going way higher, and I want to hang on to it, and that's a very different taxable consequence. 

MARK: I mean, you already have exposure to the company. You work there. You've got the options, which is a form of exposure. And then if you exercise and hold, you're maybe not literally doubling down, but you're actually increasing that exposure, right? 

STACIE: Very much so. I would say your average employee does not exercise and hold. It's typically part of their long-term plan to kind of move that stock along, so they're not doubling down so much. Whereas you may see executives and C-suite members holding onto that stock, as that signals to the marketplace that they believe in that stock. 

MARK: So you raise an interesting point there about their long-term financial plan. So these are an investment, right? So how does the equity compensation, how do you think about that within the context of somebody's broader financial picture? 

STACIE: If you have a financial plan in place, that is a great opportunity to look at your future and not make immediate decisions as soon as you get that money. 

Plan on it long-term. If it's an RSU, you know you have a timeframe to work with those shares. If it's an option, you still know you have a timeframe to work with those shares. And it definitely is intended to be a wealth generator, as well as to really make you an owner of the company, a long-term employee. So you're kind of doubling down on your employment in that case as well.

MARK: And then if you're concerned about that, there's really … kind of one answer, which is to slowly … 

STACIE: Yes

MARK: Or maybe quickly, I guess. Yeah, you know, get rid of that position. 

STACIE: Yeah, sell off that stock. 

MARK: Diversify, right? 

STACIE: Right, diversify. 

MARK: I think, I don't know how many episodes we've done of this show, but I think the word diversification has come up in at least—probably every single episode now that I think about it. 

So what is the maximum exposure to a single company that you should have, especially if it's your employer, because to a certain extent, your human capital is tied up in that company. How far do you want to go down that path before it really gets to be something that maybe some warning lights start to go off? 

STACIE: Sure. Just like a regular investment portfolio, we typically are looking at when you have one investment position, trying to keep that at 20% or not too much more. 

Obviously, there's individual situations that may require more, or perhaps there's some emotional things going into that. But from a sound investment choice, you should work with a financial professional, and you should really be aware of that percentage rate and be careful about getting too high. 

MARK: Yeah, I like to think of it as there's two aspects of risk. Can you financially afford to take the risk if it doesn't pan out? And can you emotionally stomach the risk in case it doesn't pan out? But again, I think you're right. At the end of the day, it's going to be an individual decision that everyone has to make and live with. 

STACIE: Right. 

MARK: Stacie, as we're recording this, it just happens to be we're nearing the end of kind of earnings season. And I've heard many, many, many big companies announce that they're laying off, you know, 5,000 workers, 15,000, 20,000 workers. So what happens if you've got unvested  either stock options or restricted stock units, you're not vested yet, and you get laid off. What happens? Can you get those? Are they lost? Tell me about that. 

STACIE: That really depends on how your employer created that plan and how that award was granted to you. They have two options: 

They can pay those out. That's called accelerating those awards. Perhaps they accelerate a portion of those awards or all those awards to you as part of your severance package. 

They also have the right, unfortunately, to take those and cancel those awards, and you would not see those funds if you were laid off. I would say most land on the generous side of giving you some acceleration, but maybe not all. 

MARK: Over time, you've worked with individuals, tell me a little bit about what are the mistakes you see people making, or where are people kind of tying themselves into knots a little bit when dealing with this? 

STACIE: The biggest mistake we see is especially in newly public companies, initial-public-offering companies. Typically, people are given grants at very low prices. And if a company that IPOs hits it out of the market, now you're talking about big dollars. Truly those companies can make millionaires overnight. And big dollars equal big emotion. It's pretty tempting when you get a grant that is all of a sudden—you thought not worth much—and just happens to have taken off and worth hundreds of thousands of dollars. It's pretty tempting to go buy that boat or go on that crazy vacation that you've always wanted to go on or do crazy things that you are not saving for. You're not really thinking about an investment future. That is the thing we see most with young people, especially, big dollars, big emotion, instead of thinking about their future. 

MARK: And do you get the sense that most people you've worked with are, let's say, maybe overconfident or looking at the company with kind of rose-colored glasses? Because as you were talking about, some of the numbers can be pretty substantial. 

But we hear less about the companies that don't go through a big IPO, right? So how do you balance making sure people are getting a realistic projection of what the future could hold, both positive and negative, with these companies? 

STACIE: Yeah, and I think that's a great point. If you've got a very stable company, and you believe in that company, and you've had long-term employment, you may fail to diversify because it's part of your emotional makeup about who you are inside that company and those shares are you and you are them, right? 

Not diversifying at all is just as big of a mistake and as big of an emotional mistake as big dollars, big purchases. It can go the absolute opposite way in a real fast way. We learned many, many years back with other companies, where regulations had to be made so you couldn't hold too much stock in a company, and it was told to you not to, right? 

People have forgotten about those days. That's what happens to us, right? But we always need to be aware that anything can change in the market, and you really need to be thoughtful about planning for ups and downs. 

MARK: I guess another thing to think about it when you put it that way is, for certain types of companies, equity compensation may be a bigger piece of the total compensation pie than it is for other companies. And you got to think about that in terms of prospective employers, right? 

STACIE: Absolutely. I mean, what you're going to see is, in every public company, they're going to issue their executives stock. Not every public company is going to issue every other employee stock. It's fairly common in the tech industry, especially the Silicon Valley, the high-tech folks, that it's really kind of a demand of those employees, that is part of their package. And you think about that and try to understand they're creators. They're bringing to the company their thoughts, their thought licensing. They want a piece of that pie. And so that's why they're receiving that ownership benefit of that stock and why it's such a large part of their compensation. 

Other companies, you're not going to have that. And it may be more just focus, say, towards an ESPP, where we'd like you to voluntarily participate in a plan where it gives you some level of ownership. But we're not getting necessarily anything, you know, just as in a grant. We'd like you to participate with your paycheck dollars in that. 

MARK: Yeah, and we may allow you to buy it at a discount, right? 

STACIE: Absolutely. 

MARK: That's one way, right? 

STACIE: In fact, maybe even give you a few more benefits out of that discount, if potentially what we call a look back, so you may get it at a lower price, even than that 15% discount. That's potential for some employers as well. 

MARK: Yep, exactly. Last question for you, Stacie. What are some of your thoughts on the direction that you see equity compensation heading? Do you see any particular developments that are on the horizon, maybe something being offered by a relatively small number of companies that may be getting bigger? Do you see the decline in options continuing? What's your expectations? 

STACIE: I do think the decline in options, it's made itself clear that's continuing to happen. That's primarily been reserved for the C-suite. For the broad-based folks, we are seeing some grants. 

Some companies have started to, instead of give cash bonuses, give their bonuses in stock now. That is not necessarily performance-based, but it does have a little bit of a flair to the company performance base. They want you to be an owner. They want you to want those shares and have a potential wealth generator in your pocket instead of just that cash. 

And then I would say we have definitely seen an increase in ESPP plans. Those are becoming much more popular than they had been. They've always been fairly popular, but it's a great way to add to your overall just retirement plan as well and have some control over that. 

MARK: Stacie Sands is a Certified Equity Professional and a director in Schwab's Stock Plan Services group. Stacie, thanks for being here.

STACIE: Thank you, Mark. Appreciate it.

Before I wrap up, I wanted to build on one of Stacie's comments. She rightly pointed out that tying a significant chunk of your financial portfolio to the future of a single company can be a risky choice.

It's not inherently good or bad. It is what it is, and like most risks, what matters most is that you understand what kind risk you're taking and you're fully informed about both the upside and the downside.

So yes, diversification is a good thing. It makes sense to watch out for having any one company be too large a percentage of your wealth. But what is wealth? Here's where a known decision-making bias pops in. When making a decision, we look at them too narrowly. 

Let me give an example that's relevant for people at or near retirement, and that is how much to put in bonds. Before you make that decision, you should think about your portfolio as also including your Social Security benefits. Those benefits perform many of the same functions as the bonds in your portfolio. 

So the question you want to ask yourself is, how much do I put in bonds, given the investments I have in the rest of my portfolio, plus my Social Security benefits?

Getting back to equity compensation, a narrow definition of wealth might include just your financial assets. A broader definition would include both your vested and unvested equity compensation. A still broader and the best definition would be to define wealth as all your assets, including your human capital.

By "human capital," I mean the earning power that is made possible by your skills, knowledge, education, and experience. For younger people their human capital is probably worth far more than their financial assets.

Not only that, human capital has two components. One piece is comprised of your skills that are general and valuable to any firm. The other piece is specific to your employer, and that piece is especially important for workers who are at the higher levels of the company.[2]

If your employer does extremely poorly, your firm-specific human capital might take a hit, as well as your financial capital in the form of equity compensation. In more concrete terms, your equity compensation might be worth less, and if you were to leave your firm, it may be more difficult to find a position with the same salary and seniority at another firm.

Now, I don't want to come across as all doom and gloom. On balance, I think equity compensation is a good thing. It gives employees an opportunity to be on the side of owners and have a direct stake in the future success of the company.

Plus, if you're already at a company, and it offers you equity compensation because you're valuable and they expect you to continue to be valuable, of course you should take it. The biggest decisions come into play after the vesting period ends and you've got to decide whether to hold or sell and deal with the tax consequences.

Of course, it's impossible for me to give specific advice on a mass-market podcast, but if you find yourself in that situation, start by devouring all the educational material you can get from your employer and then consult a financial advisor if you still have questions.

You can also go to schwab.com/learn and type "equity compensation" into the search bar.

There we have articles about what happens if your company goes IPO, how performance stock units affect your taxes, making sense of 10b5-1 plans, and many more.

That's it for this episode of Financial Decoder.

I'm Mark Riepe, and if you'd like to hear more from me, you can visit my LinkedIn page or follow my account on X @MarkRiepe. M-A-R-K-R-I-E-P-E.

Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts. And if you know someone who might like show, please share it and let them know that they can follow us for free in their favorite podcasting app.

For important disclosures, see the show notes and schwab.com/FinancialDecoder.

[1] Percy Handcock, The Code of Hammurabi, Macmillan: 1920. 

[2] Illoong Kwan and Eva M. Meyersson Milgrom, "The significance of firm and occupation specific human capital for hiring and promotions," Labour Economics, 2014.