How Can a Company Director Purchase Common Stock at a Huge Discount?

Introduction to Stock-Based Compensation

For publicly-traded companies in the United States, it is not uncommon for company directors—both employee directors and independent directors—to receive a significant portion of their compensation in the form of stock. There are two primary methods by which this stock-based compensation is provided: stock options and restricted stock units (RSUs).

Understanding Stock Options

Stock options provide the recipient with the right, but not the obligation, to purchase common stock at a predetermined 'strike' price, which is usually based on the market value at the time of grant. These options typically vest over a period of years, allowing the holder to exercise them when vested. Ideally, the value of the stock appreciates during the vesting period, enabling the employee to purchase the stock at a discount to its current market value and thereby realizing a gain when reselling the shares at the current market price. However, if the market price is lower than the strike price, the options become underwater, resulting in no profit.

How Restricted Stock Units (RSUs) Operate

RSUs function in a conceptually similar manner, but with a significant difference. The 'strike' price for RSUs is often a nominal amount, typically just a penny. This nominal strike price makes the value of RSUs almost impossible to be underwater, due to their low entry cost. This arrangement ensures that the directors can always benefit financially from the growth of the company's stock price.

Case Study: A Director's Stock Purchase

Consider the example of Richard Burke, a director. On 21 July 2017, Richard acquired 1080 shares of UNH (UnitedHealth Group) at a price of $48.43 per share, apparently based on the form 4 filing he made. At that time, the market value of UNH was approximately $190 per share. This example highlights the potential for a significant discount in purchasing shares through restricted stock units (RSUs).

Implications of Stock-Based Compensation

The use of stock options and RSUs in compensation packages for directors has several implications. First, it aligns the financial interests of the directors with those of the company's shareholders. As the directors' wealth increases with the company's stock price, their interests are closely tied to the success of the business. Second, it incentivizes long-term decision-making, as the benefits from holding onto the shares often accrue over time.

Conclusion

Understanding the mechanics of stock options and RSUs is crucial for any company director and investor. The ability to purchase common stock at a huge discount through these mechanisms can significantly enhance profitability and provide a powerful tool for aligning the interests of directors and shareholders. As markets continue to evolve, the strategic use of stock-based compensation will remain a key factor in the ongoing success of publicly-traded companies.

Keywords: company director, stock options, restricted stock units (RSUs)