Most executives realize that if their employer were to file bankruptcy, an unfortunately very real risk for many this past year, their stock benefits will be lost. This can be a tough pill to swallow as stock awards can represent a large portion of an executive’s compensation and wealth. This outsized risk requires careful management and consideration over time.
I find it to be particularly interesting that most executives don’t realize that if a bankruptcy is imminent, they can be treated worse than general shareholders in two big ways: taxes and liquidity. These two hits pour salt in the wound as the executive often second guesses past opportunities to realize stock benefits.
First, many executives are restricted to when they can buy or sell company stock. This is known as liquidity risk. I won’t go into the legal implications here but due to these restrictions, executives have a much smaller window to operate within than a general shareholder able to buy and sell any day the market is open. This means that if the company stock price is swinging wildly, the executive may be prevented from selling stock and liquidating stock benefits. Even as the ship may be sinking, their hands may be tied.
Next, employees with stock compensation will get the short end of the stick again when it comes to taxes. For general shareholders (which the employee/executive may also be), if a company files bankruptcy and their stock is rendered worthless, the investor can “take a loss” on their taxes based on how much they invested into the company (disclaimer: discuss with your CPA any tax considerations). Paying less taxes is a small consolation for lost investment. But for employees with stock compensation such as stock options (NQO’s & ISO’s), or unvested performance shares (PSU’s) and restricted stock (RSA’s & RSU’s), they have not technically invested their own capital and do not own those assets yet. Therefore, they have no taxable loss to write off when it comes to tax time. Yes, I know, you “lost” all that value and wealth, but you’ll get no tax benefit for it. Painful.
Understanding these situations can help employees and executives better understand their benefits which as a result could create better decision making BEFORE the terrible reality of an employer bankruptcy. Next week, we will be discussing what happens to deferred compensation when your employer files bankruptcy. That can also get ugly, so if you have, or are considering using your employer deferred compensation plan be sure to check back next week for more information on that!
- Tim Golas