Replies to post #185621 on Biotech Values

[DewDiligence]

I’m confused—are you rescinding your statement in #msg-54034666?

[DewDiligence]

Re: Exercise-and-hold-all-shares transactions

If you don't sell to cover then you are effectively buying more stock now, which distorts the subsequent comparison.

I would argue that an exercise-and-hold-all-shares transaction being tantamount to buying more shares (because of the need to satisfy the tax liability) is exactly the point and the reason such a transaction is bullish.

Thus, I agree with your original contention in #msg-54034666 and I disagree with your new qualification in #msg-109706460.

[iwfal]

Of course I wouldn't expect most execs to understand this anyhow, so likely it still is a bullish signal. :)

FWIW if you assume that they have to sell off some of the assets and that the income bracket is 40 percent vs 20 percent for LTCG then it is always better to not exercise if you think the stock is going to go up. Because the appreciation you get to keep on the stock you would have sold for tax reasons more than offsets the lower tax rate.

Or, think of it another way... If you keep the stock the total number of shares you had to use to pay taxes was 40% of your holdings. But if you exercise early you end up paying that AND some more.

Obviously it ends up a lot more complex if you are willing to pays taxes out a of different bucket. E.g. Something like this happens when you transfer traditional IRA to Roth IRA and pay the taxes out of ordinary income.

And you are correct we discussed this perhaps 2 years ago. And it is still surprising to me that presumably intelligent execs are clearly doing what Dew proposes. Taxes just make people irrational. E.g. People often act to minimize taxes even when that hurts their own income.

[jq1234]

>> Very likely it is sub-optimal to ever exercise early - the apparent gains come only if you ignore the extra cash you have to pony-up to avoid selling shares to cover taxes at the time of the exercise.

It really depends on one's tax situation. Your example is over simplified tax situation where withholding tax rate 40% federal/state at earlier exercise is the same as marginal tax rate of later exercise. They can be quite different. Withholding rate of 40% is a reasonable assumption, marginal tax rate is not for many high income people. For many of these executives, any gain from exercise via ordinary income and short term capital gain would fall into federal marginal tax rate of almost 40% while state of MA tax rate for short term capital gain is 12% compared to 5.2% for long term capital gain and ordinary income. This can change the equation decisively.