Page 431 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 417

Frequency of Grants
Multiyear vs. Annual. It used to be common practice to grant options every three to
five years; however, annual grants are now by far the most common action. Fewer shares on
a more frequent basis minimizes the impact of rising compensation and swings in the price
of the stock, as well as the visibility of large grants to insiders. If options are not granted on
an annual basis, the company will need a mechanism for interim (off-year) grants to new hires
and the recently promoted.

Catch-ups with Multiyear Grant Periods. When interim or catch-up grants are made
between normal grant dates, the regular stock option grant guidelines are adjusted by the
following: the estimated future market value, the previous grant (number of shares and
option price), the extent of lapsed time since the regular grant, and the current option price.
These requirements are expressed in the formula shown in Table 8-9.

RT [NS (FMV OP )] [NS (FMV OP )] NS (FMV OP )
g m m m c f c
RT percentage of time remaining before next major grant
NS number shares granted this grade in last major grant
g
NS number shares granted this person inmajor grant
m
NS number shares to be granted this person in catch-up
c
FMV estimated fair market value of stock at time of next major grant
f
OP option price of last major grant
m
OP option price of catch-up grant
c
Table 8-9. Formula for interim or catch-up stock option
Assume the company has a three-year grant cycle. One year after the stock option grant,
one individual was promoted after receiving a grant of 8,000 shares. In addition, one person
was hired into a grade that last year, during the major grant, called for a normal award of
10,000 shares with the stock price at $100. The stock is currently at $110, and the growth
rate is anticipated to be 10 percent a year (or $133 a share two years hence at the time of the
next major grant). The known values are shown in Table 8-10. Rounding the results would
suggest granting 9,613 shares to the new hire and an additional 1923 shares to the recently
promoted individual.
However, the formulas in Table 8-10 erroneously equate a straight-line relationship
between time and an increasing stock value effected by compound growth; nonetheless, this
is not a serious flaw given the fact that the solved unknown is most likely to be rounded and
otherwise adjusted by management judgment. In addition, formulas can be developed to use
present value, if that is deemed appropriate. Regardless of the approach, the basic logic is to
give options to recent hires and promotions that equate to the major grant optionees only for
the remaining time until the next grant. Using the above approach (or for that matter, any time-
adjusted formula), the catch-up grant will be too generous vis-à-vis the previous major grant
if the stock price is greater than assumed; conversely, it will be too low if growth in the stock
price is less than assumed. In our example, the issue is plus or minus the assumed $133.
The problems of catch-up grants are essentially eliminated with the use of annual grants.
In addition to responding to organizational changes, they allow for fine tuning with regard