Page 342 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

328 The Complete Guide to Executive Compensation

6. The purchase price cannot be less than the lower of 85 percent of fair market value
(FMV) at (a) time of grant or (b) time of purchase or exercise.
7. Where the grant is set at not less than 85 percent of FMV at date of exercise, the pur-
chase period may run as long as five years. If the purchase price is not set in this manner,
the purchase period may not exceed 27 months.
It is not unusual for plans to have a dozen or more investment alternatives. Adding Self-
Directed Brokerage Accounts (SDAs) provides access to thousands of mutual funds.
8. No employee may be granted an option that exceeds $25,000 of fair market value for
each calendar year in which the option is outstanding.
9. The option is not transferable by the employee other than by will or the laws of descent
and distribution, and is exercisable only by the employee during his or her lifetime.

Under such a plan, the employee agrees to purchase a specified number of shares or
invest a specified number of dollars (e.g., up to 5 percent of pay) to purchase company stock
on an installment basis. By terms of the agreement, the percentage discount is prescribed and
may be as low as 85 percent of FMV.
Section 423(a) of the IRC describes the requirements necessary to avoid an income tax
liability when purchasing stock through a company stock purchase plan. The employee must
purchase the stock while active or within three months of termination of employment in
accordance with plan terms. In addition, the employee may not dispose of the stock within two
years from date of grant and one year after purchase. If these requirements are satisfied, the
employee has no income at time of purchase and the gain from FMV at time of purchase to
that realized upon sale will be considered long-term capital gains. If these requirements are
not met, while the tax liability is still deferred until the individual sells the stock, the discount
below fair market value at time of purchase is taxed as ordinary income. Any appreciation
above FMV at time of purchase is subject to short- or long-term capital gains tax, depending
on length of time held.
FAS 123R has limited the attractiveness of employee stock purchase plans. Unless the
plan provides for no more than a 5 percent discount and has no look-back feature, the plan
will be deemed compensatory and (using an option valuation model) the compensation cost
will be accrued over the purchase period.
Some companies use stock purchase plans in lieu of stock options, reserving options only
for executives [see Chapter 8 (“Long-Term Incentives”)]. When stock options are reserved
for executives and executives are also prohibited from participating in the stock purchase
plan, this may create a problem. If the stock is “flat” for several years, the stock purchase par-
ticipants will realize a bigger benefit than executives. Conversely, if the stock price increases
significantly over the term of the plan, the stock option is more attractive.
Money Purchase Plans. Employer contribution is based on a predetermined formula (e.g.,
6 percent). This amount is credited to the employee’s account. The employee may also make
contributions, but only on an after-tax basis. Given the alternative of using pretax dollars with
a 401(k) plan, money purchase plans are not very common, except perhaps for employees
covered by trade union agreements.
Employee Stock Options. A stock option is the right given by a granter (the company) to
an optionee (the person) to exercise (purchase) a stated number of shares of the company
common stock (the grant) at a prescribed price (grant or strike price) over a specified period
of time (exercise period). Typically, time requirements are stipulated (vesting period) before