Tax Planning and the Exercise of Employee Stock Options
Posted: 25 Jun 1998
Date Written: March 1996
This paper analyzes tax planning opportunities when tax rates change for issuers and holders of employee stock options. Then the paper examines the response of a sample of optionees to proposed changes in the tax law alleged to have precipitated the exercise of many employee stock options in the last quarter of 1992. Consistent with tax planning, the frequency of option exercise late in 1992 is higher for high-income employees affected by the proposed tax change than for (i) lower-income employees less likely to be affected by the tax increase who contemporaneously held identical options and (ii) employees with similar incomes who held similar options in 1990, 1991, and 1993. However, a comparison of the after-tax value of an option exercised in 1992 with the present value of the expected after-tax value payoff of the option exercised in the future suggests that only 21% of employees in a sub-sample that would benefit from early exercise for tax reasons alone in fact chose to exercise early. The median value of the forgone after-tax benefit in this group is $6,741 or 2.6% of 1993 salary. Since early exercise of non-qualified options also would increase liquidity, reduce risk and AMT exposure, and would not prevent employees from profiting from private information, the findings are consistent with a reluctance on the part of some individuals to act in anticipation of tax law changes.
JEL Classification: G11, H30, K34, M10
Suggested Citation: Suggested Citation