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What to do if you've got lots of company stock

As the concept of “pay for performance” has taken root in corporate America, more C-suite executives are gaining firsthand experience with the major upsides

As the concept of “pay for performance” has taken root in corporate America, more C-suite executives are gaining firsthand experience with the major upsides — and occasional pitfalls — that can accompany generous equity compensation plans.

On the one hand, receiving payment in the form of stock can amount to a windfall: Not only are you getting stock on top of cash compensation, but those shares can appreciate dramatically.

However, stock can just as often wind up underwater, essentially worthless. And even when shares can be sold at a gain, executives have to contend with thorny issues concerning diversification and the reputational risks of selling. It can be a tricky intersection in the corporate world of trusting your company’s future versus protecting your own interests.

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The first thing to remember when receiving substantial stock compensation, financial advisers say, is that no matter how stable your company, you are taking a gamble. Markets go up and down, and even the most stalwart stocks can take sudden turns.

Shares of General Electric climbed more or less steadily for decades until the year 2000, then tumbled. They regained some ground but took another beating during the financial crisis. GE stock was climbing again in recent years but last year began falling again.

“Whether founders or executives, these individuals have a different risk appetite than other W-2 earning individuals,” said Jeff Schnitz, head of wealth advisory for Silicon Valley Bank’s private bank. “They have the opportunity to accept risk and to create upside opportunities for themselves.”

Some chief executives are taking this to new extremes. Elon Musk recently proposed a new compensation plan at Tesla. If approved, he will receive billions of dollars in compensation if he manages to double, triple and quadruple the value of the company. He will receive nothing if he does not.

Rick Smith, the chief executive of Axon, followed Musk’s lead and proposed a nearly identical plan, albeit with smaller targets for the market valuation.

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Musk and Smith are outliers. But even for less ambitions executives, the same principle holds.

“You want the CEO fully aligned and driving a strong return on the investment,” said Shirl Penney, the founder of Dynasty Financial Partners. “The investors want the senior leadership team as all in as possible.”

Not everyone is willing to put all their eggs in one basket, however. And for those making a mere few hundred thousand dollars, or even a few million a year, the need to diversify can be real.

“For someone who is more of a middle-line manager who is saving toward retirement, we would typically advise not having more than 10 percent of your net worth in any one security,” said Penney. “You try to advise someone to liquidate as much of their stock as possible and put it into a more diversified portfolio.”

That can be easy for an executive at a publicly traded company. But it can be virtually impossible for executives or founders at private startups, many of whom have preferred stock or founders shares that are illiquid until a sale or initial public offering.

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“Selling or diversifying out of that stock has not only a financial ramification for it but could have ramifications around how much control they have,” said Penney.

Even if executives or founders do want to sell stock, they need to be careful about not timing any sales to create the impression that they have lost faith in the company or were trading on nonpublic information.

Intel Chief Executive Brian Krzanich recently drew scrutiny for selling about $39 million worth of shares after the company learned of a major security flaw in its chips but before the news was made public.

Intel said the sale was unrelated to security issues and was part of a prearranged annual trading plan.

Financial advisers said such considerations were left largely to the executives themselves. “We’re not really in the business of talking to CEOs about the public perception of what they want to do,” said Scott Senseney, head of sales, marketing and communications for Fidelity’s stock plan services group.

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Sophisticated financial planners have myriad ways to minimize risk, beyond simply diversifying. Executives with large stock holdings can hedge their positions, minimizing downside risk. Sometimes it’s possible to sell upside call options.

And in so-called exchange funds, executives from various companies will pool their stock into a fund run by an asset manager, diversifying their exposure without having to sell shares and pay any immediate capital gains taxes.

Even then, however, undue complexity can backfire. In 2012, the founder of Green Mountain Coffee Roasters, Robert Stiller, was ousted as chairman of his own company after he sold 5 million shares, worth about $125 million. His motivation: He had taken out loans against his sizable stake in Green Mountain, now known as Keurig Green Mountain, but when the value of the shares fell, Stiller was caught in a margin call.

The most common pitfall for executives who are rewarded with stock, however, is simply ignorance. Too often, planners say, executives don’t know what they have, or what options they are entitled to. Frequently, people become aware of their options only at the last minute or even after the fact.

“The worst-case scenario is that those options expire in the money,” said Senseney. “Waiting too long can be devastating. There can be millions of dollars of impact.”

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This article originally appeared in The New York Times.

DAVID GELLES © 2018 The New York Times

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