Replies to post #185657 on Biotech Values

[iwfal]

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.

Agree it changes the equation in so far as it changes the magnitude of the penalty you pay for exercising and holding (while paying the exercise taxes out of the exercise gain). But it doesn't change the sign. For an appreciating stock and a given set of tax rates it is always a penalty regardless of the person's marginal income rate or capital gains rate. See my second explanation in #msg-109707411 for a reasonably intuitive explanation.

That said, I agree it is, initially, counter-intuitive. Very similar to the common mistake of assuming that it is 'obviously' better to convert a Traditional IRA to a Roth IRA (generally it is only because/if you are paying the conversion taxes out of separate current income and thus effectively increasing the amount you are putting aside into the after tax IRA)


*Note that there is an exception to both of the above counter-intuitive situations (early v later option exercising, and IRA conversion). That exception is if the person's income tax rate is expected to go up substantially by the time of final liquidation of the assets then early conversion makes financial sense (penalty becomes a benefit). But of course in neither situation (IRA or Executive with options) would the normal person expect meaningfully higher tax rates by the time of final liquidation.

[DewDiligence]

If an insider knows something materially bullish and non-public, exercising options and holding the exercised shares is the only legal way to exploit such knowledge to increase one’s effective equity stake. This, above all else, is what makes such a transaction a clear bullish signal.

p.s. I reject biomaven's contention that executives and their financial/legal advisors are too incompetent to know what they are doing.