Working with Corporate Executives | American Funds

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Michelle Black Wealth Advisory Senior Manager, Capital Group Private Client Services

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Working With Corporate Executives

Key Takeaways

  • Given the increasing complexity of equity compensation plans, positioning yourself as an expert in this field allows you to reach a highly valuable target market.
  • Incorporating stock options, restricted stock and restricted stock units into a client’s comprehensive wealth management strategy requires a detailed understanding of the client’s balance sheet, tax exposure and personal goals.
  • Diversifying equity grants in a tax-efficient manner can be achieved by following a five-step process for determining the order of liquidation.

Equity compensation plans for corporate executives have become increasingly complex over the past decade. Whereas most used to focus primarily on incentive stock options (ISOs), today many plans include a mix of nonqualified stock options (NQSOs), restricted stock and restricted stock units (RSUs). Responding to pressure from shareholders, more companies now attach performance-based vesting schedules to equity compensation. As a result, corporate executives rely on advice in managing this wealth more than ever before.

With its complex mix of equity, options, contractual restrictions and public-perception concerns, equity compensation presents a unique set of challenges for financial advisors. It is also an enormous opportunity to develop specialized expertise and a niche serving this high net worth audience.

If you are looking to position yourself as an expert in working with corporate executives, it is important to know more than how to calculate the value of stock options using a Black-Scholes model or when the window starts for qualifying dispositions of ISOs. In our view, it is also essential to understand how equity compensation can be integrated into the client’s overall financial plan, as well as the emotional biases that may shape how executives behave.


Identifying What the Client Owns

After gathering the requisite information about equity grants, you can begin sorting through the client’s potential options. At this stage, you and your client’s tax advisor are able to discuss the pros and cons of making an 83(b) election with their restricted stock. You can also identify potential issues, such as whether the client has exercised ISOs and if they have adequate cash to cover the potential AMT liability.

In addition to inputs about equity compensation, ideally you also need detailed information about other aspects of the client’s financial picture, including:

  • Overall balance sheet and cash flow statement
  • Allocations in taxable, tax-deferred and tax-exempt investment accounts and any specific sector-concentrated exposure
  • Existing holdings of company stock, including the cost basis
  • Client goals and objectives

Understanding the clients’ complete wealth picture can significantly influence the amount of risk that he or she can afford to assume in relation to the equity compensation. For example, if an executive’s overall balance sheet is very well diversified, the client might be able to maintain a concentrated equity position in company stock without that single-stock risk unduly affecting his or her overall risk profile. Conversely, if the executive is building toward a retirement nest egg and has little other assets, using equity compensation to build a diversified portfolio may take priority.

 

Knowing What the Client Wants to Accomplish

Once you’ve assessed the client’s holdings, evaluate what he or she wants to accomplish. With corporate executives, this means more than just thinking about goals for retirement, wealth transfer and philanthropy.

It requires understanding the client’s mind-set related to equity compensation. For example, does the client view it as an indirect source of cash to be used to fund lifestyle goals? Or does the client see equity compensation as a tool for building a multigenerational legacy through wealth transfer or philanthropy? This distinction is generally a function of one’s age or where the executive is in his or her career. Younger professionals often are more focused on using equity compensation to generate income to fund nearer-term goals. Whereas more established executives often have already funded these goals and are looking to use their equity compensation to build multigenerational wealth.

Furthermore, it is important to understand any restrictions — either explicit or implied — or emotional biases that will influence the client’s ability or willingness to sell company stock. Clients may not want to part with a stock because of loyalty to the company or concern that any sales would be perceived negatively by customers, employees or Wall Street. Other executives have so much faith in the prospects of their company that they want to increase their personal exposure while others have concerns about the future and want to amass a sizeable voting position. Some clients, influenced by memories of the financial crisis, may be overly risk-averse.


Developing a Plan for Achieving Those Goals

Given the complexity related to equity compensation and uncertainty about the future of the stock price, many clients get overwhelmed when thinking about equity compensation. As a result, they may put off making decisions or default to overly simplistic mental shortcuts, such as exercising and selling everything immediately or using the stock’s 52-week high or other arbitrary milestones to guide their decision-making. We have found that executives risk leaving significant amounts of money on the table when they have multiple grants types. Rather than thinking about each type individually and developing an exercise strategy that is optimized for each, some executives will default to using one approach across the board, which can lead to less favorable results than with a more nuanced approach.

If you, as the advisor, have a complete picture of what a client owns and full understanding of the different factors that may influence his or her decisions about the equity compensation, you are uniquely positioned to help the client think clearly about how to manage this wealth.


Selling Company Stock in a Tax-Efficient Manner

Once clients decide to reduce their exposure to company stock in order to increase liquidity or portfolio diversification, your focus needs to turn to selling that stock in a tax-efficient way. This decision is complicated by the fact that executives often own multiple forms of equity, including common stock held outright, grants of restricted stock and/or units, and grants of stock options and/or appreciation rights.

At Capital Group, we have developed a five-step hierarchy that you and your client’s tax advisor can use to help identify the best sources of funds for diversifying assets in a tax-efficient manner (listed below from most to least desirable):

  1. Sell stock held at a loss in taxable accounts. This helps the executive reduce direct exposure to the stock immediately while generating losses that can be carried forward indefinitely to offset gains elsewhere in the portfolio.
  2. Sell stock held in tax-deferred accounts. Transactions in tax-deferred accounts, such as the executive’s 401(k) or individual retirement account, have no tax consequences. This allows the executive to reduce exposure to the company’s stock price and reallocate funds without having to worry about the tax consequences.
  3. Exercise stock options with little time value remaining. After having diversified directly out of the stock holdings that have tax advantages, options that have little time value remaining are good candidates for exercise. Low time value suggests that the remaining upside potential of the option, given the length of time to expiration, is limited.
  4. Sell stock held at a gain in taxable accounts. This isn’t an ideal choice because of the taxable gains incurred, but selling these holdings will reduce direct exposure to the company. It may be a necessary tactic for some clients.
  5. Exercise stock options with higher amounts of time value remaining. This is the least desirable group of securities to be diversified out of in our proposed sequence. The executive who holds options does not have direct exposure to the stock. If the stock price declines, the executive experiences a drop in the potential proceeds but doesn’t actually own the stock. At the same time, by holding the options, the executive maintains the upside potential of the stock. If the options have high time value remaining, they are better candidates to continue holding.

The decision of when to exercise stock options is complex and involves a variety of factors. At Capital Group, we have developed a quadrant to provide general guidelines for exercising options based on a stock’s volatility and dividend yield that you can consider using as a complement to a Black-Scholes model.


Positioning Yourself as an Executive Compensation Expert

Becoming an expert in helping corporate executives manage their wealth can be a powerful way to grow your practice. The increasing complexity of executive compensation plans has created opportunities for financial advisors to add high-value clients who are facing critical decisions. To serve this valuable — and highly sought-after niche — you need to be able to guide clients through the psychological, as well as the tax and financial, aspects of these decisions.
 



About the Author

Michelle Black, CIMA®, CPWA®, is head of wealth advisory for Capital Group. She has more than two decades of experience implementing portfolio construction and advanced planning strategies for high net worth clients, trusts, endowments and foundations to meet an array of sophisticated objectives.


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Content contained herein is not intended to serve as impartial investment or fiduciary advice. The content has been developed by Capital Group, which receives fees for managing, distributing and/or servicing its investments.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice.