Page 434 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

420 The Complete Guide to Executive Compensation

unvested portion. However, they are not as severe in penalizing as the five-year or longer cliff
vest. While many plans vest only in full years, some vest over shorter time periods (e.g., days,
months, or quarter years).
If the option is intended as a form of “golden handcuff,” then a long vesting period is
appropriate. It could also be combined with an additional forfeiture clause such as the
requirement that the optionee sell the stock back to the company at exercise price if the
individual left before a stated period after exercising the option (e.g., five years). This is
sometimes called a clawback option, which will be discussed in more detail later.
A variation of the cliff or installment vesting schedule is a performance vest. It prescribes
the conditions under which an option will vest. An example of such a vesting requirement
would be a grant of 10,000 shares at $100 a share that will vest 20 percent a year for every
year that earnings per share increases by at least 10 percent over the previous year. A similar
approach would be where the option would vest at 20 percent a year for every year the
stock price increased 10 percent over the previous year-end close. When the option is not
exercisable unless the performance criteria have been met, it is sometimes identified as a
performance-requirement vest or an earn-it or lose-it option. This is illustrated in Table 8-11.
With this grant, if the stock price reaches $120, the executive can exercise 20 percent of the
grant, locking in a tax base for later appreciation, or wait until the price appreciates further
before taking action. These are forward vesting grants. The option’s fair value is determined
at time of grant, and because vesting is based on stock price, an option model such as
the binomial lattice is probably more appropriate than the Black-Scholes model. And since
vesting is stock-price achievement, the expense cannot be reversed if the option does not
become vested.

Percent of Stock Price Is at
Option Price
Grant Vested or Above
$100 20 $120
40 140
60 160
80 180
100 200
Table 8-11. Performance-required vesting

Another variation is the backward vest, where a stock option vests 100 percent on the
earlier of a prescribed vesting date (e.g., 8 years on a 10-year grant) or when the company
stock trades at or above a specified dollar amount on average for a prescribed period of time
(e.g., 20 consecutive trading days). This is called by some a performance-accelerated stock option
plan (PAYSOP). The performance feature could be expressed in multiple terms. For example,
if the stock option were granted at $100 (equal to fair market value), the option might fully
vest in four years, or vest 50 percent when the stock reaches $125 and 100 percent when it
reaches $150, if either are sooner than four years. Some performance vest options may use
multiple performance measurements. For example, in addition to trading at or above
$150 for 20 consecutive trading days, total shareholder return since date of grant must be at
or above the average of a defined peer group of companies. This enhanced performance-
vesting schedule rewards the optionee for a significant increase in stock price sooner. These