Page 418 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

404 The Complete Guide to Executive Compensation

This chapter will describe the various types of plans available as well as their likely
accounting and tax treatment. Design objectives are also reviewed, since certain plans are
more or less attractive depending on the objectives.

ELIGIBILITY

As with short-term incentive plans, eligibility may be determined using key position, salary,
job grade, title, reporting relationship, or some combination of these methods. Typically, the
degree of organization penetration from the CEO down is not as extensive as with short-term
incentive plans if the eligibility basis is tied to those who have an impact on the long-term
success of the organization. This criterion would relate to a time-span measurement of deci-
sions and actions. Namely, what is the length or span of time that must pass before measur-
ing the appropriateness of the decision/action? Typically, this correlates rather well with
organization level since the longer-term, larger-risk decisions are handled at the top of the
organization. For example, a decision to build a multimillion-dollar plant will not only take
several years to complete but even longer before it returns the cost of investment.
Conversely, the time lapse to determine whether a janitor has satisfactorily cleaned an office
is virtually at time the task was completed. In between these two extremes lie the other
organizational jobs.
If the driving reason for eligibility is an egalitarian view that all employees should
participate in the long-term plan (the time-span measurement would determine only the
extent of participation), then eligibility might extend all the way down the organization. We
saw in Chapter 6 that the most prevalent form of such broad-based plans is the stock option.
While methods for determining eligibility are similar to those discussed in Chapter 7, it
could be argued that only those executives whose performance period exceeds a year (because
it takes longer to determine the impact of their decisions) should be included in long-term
incentives.
However, there are other reasons to include people in long-term incentive plans.
Retention is one such reason. The multiyear nature of the plan, typically with multiyear
earn-out periods before the recipient is eligible or vested in any benefits, make long-term
incentives one of the more viable retention pay elements. Another reason for including
individuals in long-term incentive plans when company stock is used is to promote owner-
ship in the company. This should also be an incentive to do what one can do to increase the
price of the stock. Such an objective also puts stock in friendly hands.
This is not to say that a portion of an executive’s total compensation cannot consist
partly of short-term incentives, but rather that a significant portion should be based on the
longer time span for adequate assessment, especially for chief executive officers and other
highly placed individuals whose decisions affect longer time frames in the future.

ACCOUNTING, TAX, AND SEC IMPLICATIONS
The accounting rules for long-term incentive plans are not as simple as with short-term
incentives. All compensation is a charge to the earnings statement. Under FAS 123R, it is
either measured at date of grant or on date of settlement. The first applies to stock-settled
awards; the second applies to those settled in cash. The first accrues the fixed expense over
the vesting period; the second is a variable accrual “trued up” at time of settlement.