Google has been an exceptional success story and will continue to be a driving force in the evolution of the internet for the foreseeable future.  The Company remains in excellent financial shape and does not face the survivability issues troubling so many other companies and industries that are at the mercy of the credit markets.  As the world’s largest seller of online ads, though, the global economic meltdown has had a material impact on Google’s operations and will continue to dampen its growth prospects. 

As a result, Google has a serious problem routed in its famed culture.  In the last year Google’s stock has fallen by $450 a share.  This decline represents an extraordinary loss of value for its employees and managers and is particularly troubling for the Company given its employment compensation philosophy.

The Company has always promoted an entrepreneurial compensation structure and relied on stock options to attract, retain and motivate talent.  This dynamic has worked well historically.  The formula involves paying employees below market salaries and supplementing compensation with generous stock options awards.  Such a structure is attractive as it correctly aligns the incentives and motivations of employees with management and shareholders. 

The system works wonderfully for fast-growing, private companies with bright futures.  Employees see steady and quantifiable development within a rapidly expanding, private company, while the promise of an eventual public offering acts as a compelling recruiting and retention tool. 

The public markets are wonderful tools for monetizing ownership stakes and accessing the capital markets.  As prices rise steadily current employees are happy and prospective employees clamor for the opportunity to participate in the good fortune.  From the time of Google’s IPO in late 2004 through December of 2007 the Company benefited from this phenomenon as the stock price rose dramatically from $100 to $725 per share.

The public markets have a downside though.  A stock’s price performance is beyond management’s control and can be highly volatile.  Sometimes the public markets can get ahead of themselves to harmful result.  Employees see stock prices at all time highs and expect further gains.  Stock option owners tend to evaluate their holdings relative to historical highs.  Recent hires who received stock options find themselves increasingly underwater and unlikely to earn a return off of their labor for years to come.  Concerns over the ability to monetize stock options prior to expiration become an increasing concern.  As the luster comes off of Google’s stock, potential employees are less willing to take below market compensation based on the expectation of option-based wealth gains.

The expectations of current and prospective employees will continue to evolve.  I am sure that most Google employees remain optimistic about the firm’s future.  And they should.  But the Company remains at the mercy of the public market’s perception of the firm’s value as well as global macroeconomic trends.  It is unlikely that Google will experience the kind of explosive growth over the next few years that will result in meaningful stock price appreciation. 

Every employee who has been hired since late 2005 has been granted stock options that presently have no intrinsic value.  Longtime employees have seen their paper net worth’s crater as the stock has declined by $450 a share.  GOOG’s stock price has been declining steadily for a year now.  How long will talent work for an uncompetitive base salary while in possession of underwater options with the increasing perception that the stock is unlikely to rise for the next several years?  How long a period of time must the stock decline for existing and potential employees to view the wealth generating prospects of working at Google to be relatively unattractive?  How low does the stock’s price need to go before Google employees begin to voice their displeasure or pursue more rewarding compensation opportunities?

GOOG’s persistent, relative underperformance will require a systemic change to the Company’s compensation philosophy in order to compete for the caliber of talent necessary to perpetuate Google’s competitive advantage.