Why can exercising stock options can create cash flow problems for managers at the exercise date? What is an alternative to this problem?
Because the manager must pay the exercise price and may have to pay taxes on compensation in order to acquire the stock, which he or she may want to hold rather than sell.
An alternative share-based compensation program eliminates a manager's need to pay the
exercise price. At the grant date, the manager could be given shares of stock rather than
options (far fewer shares than options because the fair value of a share is usually greater
than the fair value of an option to purchase the stock). The stock cannot be traded until the
vesting period is completed (restricted stock). Or the manager could receive non-tradable
rights for a number of shares of stock once the vesting period is completed (RSUs). In
concept, the accounting for stock options, restricted stock, and RSUs is similar except
for the fact that stock is issued (or restrictions placed on trading already issued stock will
be removed) once the vesting period ends.
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