Page 435 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 421

are typically called performance-accelerated vesting grants. Like the performance-required
vested option, the fair value cannot be reversed if not exercised, although it is less likely given
the 100 percent vesting after eight years (unless the stock price falls below option price or the
person leaves before eight years).
Another situation in which the grant might be 100 percent exercisable sooner than the
prescribed vesting schedule is at time the company is bought, or at least a stated portion
of shares (perhaps 20 percent of the total outstanding) are owned by one individual or
company. Called a change of control vest provision, it is common for it to be written into the
option grant. While stock option grants may become immediately vested, by terms of the
plan, individuals may be required to hold acquired shares for a stated period of time, or not
sell more than a stated number each year. A variation would be to vest the grants only if the
individual were subsequently terminated by the acquired company. Conversely, if a business
unit is sold, rather than have the option cease on date of sale extending the exercisable date
for one year gives an individual a little more leeway in his or her financial planning.
Effect of Terminating Employment. Should the individual terminate employment, many
plans provide a very limited exercise window (e.g., 30 days). In cases where the individual is
quitting or being terminated for cause, the option may logically cease on date of termination.
Periods of six months to one year, on the other hand, are not uncommon after termination
due to disability or death. On the other hand, many nonqualified plans simply use IRS rules
for qualified plans, namely, three months from date of termination, except for disability
(one year) or death, where it runs the term of the option.
If disability status does not constitute termination of employment, eligibility continues
until service ends, at which time the exercise eligibility will continue for one year unless the
individual has retired. In this case, retirement provisions will apply.
As for death, some plans distinguish between death while an active employee or as a
retiree. With both, the grant may be fully vested, but the while-active exercise period may only
extend for a year whereas the while-retired period would extend for the full term of the grant.
A few companies may also take a more liberal view for retirement, allowing the option to run
to its normal expiration. Additionally, some companies waive vesting provisions, making the
full grant exercisable in exchange for an agreement that the individual will not engage in
competition with the company or act in a way that is reasonably determined as materially
harmful to the company. A range of possible exercise periods is shown in Table 8-12.
Stock Price. Option price is set in one of three ways: equal to market value, below market
value, or above market value. Still the most frequently used approach is to set grant price
equal to fair market value (FMV) at the time of the stock option grant. Typically, this is
calculated as being equal to the average of high and low prices for the grant date. Another
approach would be to set the price equal to the closing price of the stock on the date of grant.

Market Value. Pricing an option equal to fair market value was the popular approach
because there was no compensation charge under APB 25 if the number of shares under
option were also known at time of grant. Although APB 25 no longer applies, fair market
value at time of grant is still the most popular method.

Below Market Value. For grants priced below market value, the price is either determined
at date of grant or calculated during the term of the grant in accordance with a prescribed
formula. An example of the first would be an option price set at $85 at time of grant when