The Strategic Employee's Guide to Equity and the Sunk Cost Fallacy

The sunk cost fallacy is the tendency to continue with a behavior or endeavor because of previously invested resources (time, money, effort) even when that behavior is no longer the most rational course of action. Essentially, it's letting the past dictate your future decisions, rather than evaluating the present situation objectively. Think of it like this: You buy tickets to a concert you were excited about, but on the day of the concert, you wake up feeling terrible. You know you'd have a miserable time, but you go anyway because "you already paid for the tickets." Those tickets are a sunk cost. The money is gone, regardless of whether you go or not. Staying home to rest would likely be the more beneficial decision, but the sunk cost makes you stubbornly follow through.

Why is this relevant to your equity compensation?

Equity compensation is a long-term game. You often vest over several years, and your financial well-being is tied to the company's performance and your own role. The sunk cost fallacy can creep in at various points:

• Vesting Schedules: You've worked hard and dedicated years to vest in your equity. The thought of leaving before your options are fully exercisable or your RSUs fully vest can feel like you're "leaving money on the table." This feeling can be particularly potent if you're considering a career change or if the company's future looks less promising.

• Exercise Price of Options: Let's say you have stock options with an exercise price of $10 per share. The company's stock price has dropped to $5 per share. Exercising your options seems like paying $10 for something worth $5. You might hold onto them, hoping the price goes up to avoid the loss, even if the probability of that recovery is slim. You might even feel emotionally tied to the options because of your past dedication.

• Long-Term Commitment: Maybe the company culture is no longer a fit, the work is unfulfilling, or growth opportunities are limited. However, you might feel compelled to stay, solely to protect the equity you've already earned, even if another job would lead to more long-term happiness and growth.

How the Sunk Cost Fallacy Manifests in Equity Decisions (With Examples):

Let's explore some concrete scenarios:

Scenario 1: The "Lost Potential" Trap

• Situation: You have RSUs vesting over four years. You're two years in and are unhappy with your role. You've received a great job offer at a different company, offering similar compensation but better growth opportunities. However, you have two more years of vesting to go.

• Sunk Cost Fallacy in Action: You think, "I can't leave now! I've already worked so hard for these RSUs. That's so much unvested equity I'd be forfeiting. I'll just stick it out for two more years."

• Rational Approach:

  • Evaluate the new opportunity objectively: What is the growth potential, company culture, job satisfaction of the new role? Does it outweigh the cost of forfeiting unvested equity?

  • Calculate the actual value: How much is the unvested equity worth now? (Remember, it has not vested, and is subject to the company's success). Is the growth potential of the new role worth giving up some or all of the potential from the unvested equity?

  • Consider the opportunity cost: What could you gain in those next two years by leaving? Are you sacrificing your career growth and happiness for the sake of unvested equity?

Scenario 2: The Underwater Options Dilemma

• Situation: You have stock options with an exercise price of $20. The stock is now trading at $10.

• Sunk Cost Fallacy in Action: You think, "I can't sell or let them expire, I'd be losing money! I'll hold onto them because the stock must eventually rebound to $20!"

• Rational Approach:

  • Forget the past: The fact that your exercise price was $20 is irrelevant. You're at $10 now. Evaluate the future of the company and the stock price as it is now.

  • Would you buy the stock at $10 today? If not, then holding the options may be illogical. If the future is bleak, letting them expire and focusing on future opportunities may be the better choice.

  • Time Value of Money: Even if you believe the stock might go back up to $20, how long will it take? Is it worth tying up your money and your emotional energy for potentially years without any return, especially considering the opportunity cost?

  • Consider other factors: Are there opportunities to purchase the company's stock at the current price and benefit if it does increase? What are the tax implications of your options?

Scenario 3: The "I've Been Here So Long" Phenomenon

• Situation: You've been at the company for 8 years. You’ve vested in significant amounts of stock. Your job has become repetitive, and you're no longer motivated or challenged.

• Sunk Cost Fallacy in Action: You think, "I've put so much time into this company. I've worked so hard to earn all this equity. I can't just leave now. I have to stay and make it work."

• Rational Approach:

  • Separate your past from your future: Your past work is valuable, but doesn't justify being unhappy. Look at your current situation objectively.

  • Assess the potential: Does staying offer real prospects for growth and challenge, or are you just going through the motions?

  • Weigh the long-term costs: What is the cost of staying for your career growth, your happiness, your overall well-being? Staying just for equity isn't always a great deal.

How to Overcome the Sunk Cost Fallacy:

Here are some strategies to help you avoid falling prey to this common mental trap:

1. Focus on the Future, Not the Past: When making decisions, don't dwell on past investments. Instead, focus on future benefits and potential downsides of each option.

2. Ask the "Would I Do This Today?" Question: Would you buy this company's stock at its current price today? Would you take this job today if you had a similar offer at another company? If not, why continue with the current plan?

3. Seek Objective Advice: Talk to a financial advisor, mentor, or trusted friend who can provide an objective perspective on your situation.

4. Calculate the Real Value: Don't just focus on the potential value of your equity; consider the actual present value and the probability of reaching that potential.

5. Recognize Emotional Bias: Be aware of how your emotions and the feeling of "loss aversion" can influence your decisions.

6. Consider Opportunity Cost: What are you giving up by staying in your current situation?

Equity compensation is a valuable benefit, but it should be a tool that enhances your overall financial and professional goals, not an anchor that drags you down. Don't let the sunk cost fallacy trap you into making decisions that are no longer in your best interest. By understanding this cognitive bias and adopting rational decision-making processes, you can make the most of your equity and your career. Remember, your past hard work is valuable, but your future decisions should be guided by what is best for you, not by an emotional attachment to what might have been.