Page 367 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 7. Short-Term Incentives 353

Forms

Timing Cash Stock Combination
Current 1 4 7
Deferred 2 5 8
Combination 3 6 9

Table 7-5. Form vs. timing of short-term incentives

mortgages and college tuition), this time-form combination is probably most popular with
persons in their thirties and forties. Companies that pay within 75 days of the close of their
fiscal year usually can take a tax deduction in that year rather than when paid.
If the award is all in stock (#4), the recipient may have difficulty paying taxes without sell-
ing some of the stock, thereby partially defeating the objective of giving the executive an
investment in the future growth of the organization. For this reason, a combination (#7) form
of stock and a sufficient amount of cash to pay taxes on the total award is a logical approach.
For many, this would argue for half the value in stock and the other half in cash (to meet tax
liabilities). The company must determine how much choice, if any, the individual has in
selecting a portion of the award in stock.
Deferred cash (#2), deferred stock (#5), and a combination of the two (#8) could be the
result of voluntary deferral, mandatory deferral, or a combination of the two. For example,
the company may mandate that the portion of the award not tax deductible to the company
under Section 162(m) of the IRC be deferred until leaving. Mandatory deferrals are typically
unpopular with executives, who believe they must earn the bonus twice—first by performance
and secondly, by remaining to collect it. Given their unpopularity, not surprisingly very few
plans require a mandatory deferral. Some plans make deferrals more palatable by crediting
some form of appreciation, but many companies will not permit a voluntary deferral because
it also defers the company tax deduction. The issue of deferred compensation was reviewed in
some detail in Chapter 3.
A combination of current and deferred cash (#3), current and deferred stock (#6), and a
combination of current and deferred cash along with current and deferred stock (#9) addresses
both current and future income needs. Again, the deferrals could be voluntary, mandatory, or
a combination of the two.
In addition, use of company stock need not be restricted to those on the corporate staff.
Using stock for divisional awards reinforces identification with corporate success, not simply
divisional performance.
Companies that pay a large amount of the award in company stock must realize that they
are placing heavy liquidity pressures on the individual unless the person is free to sell a
portion of the amount. For companies that pay the total award in stock, tax requirements
create a significant concern for recipients. Companies that pay half in cash and half in
stock and also discourage employees from selling the stock portion in effect create a salary
reduction plan with a heavy shift to deferred income.
Paying all or a portion of the award in stock also poses problems for corporate officers
due to the requirements of Section 16(b) of the Securities Exchange Act. It stipulates that
any profit made by an officer or director of a company by purchasing shares of the company
within six months of selling similar shares must be returned to the company.