Page 451 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 437

Other decisions that need to be made include the following: Who will be eligible? (Some
companies have excluded top executives.) When will the grants vest? When will they expire?
Granting an additional stock option will of course require a charge to earnings. The
amount will be dependent on the action. Alternatives include pulling forward the next
scheduled full-sized grant (and possibly shortening future cycles) or granting a shorter-term
option. One example is the truncated option, which would vest when stock price returned
to the option price of the underwater grant. It would expire six months later, giving the
optionee a limited period to act. This is also called a collared stock option. Shorter-term grants
obviously have a lesser earnings charge than a 10-year grant. Alternatively, the company
could grant restricted stock, probably based on a fair-value equivalent. Grants that vest in six
months (on the presumption a new grant would be made at that time) are called glue grants,
presumedly in the belief that they will cause the individual to stick with the company for
that period.
Alternatively, a restricted stock award could be made with a longer term (e.g., five to
seven years) with or without a performance feature. The advantage of a restricted stock
award is its retention feature: if the person leaves before the restrictions lapse, the award is
forfeited and the expense may be reversable.
Option reload, sometimes called a replacement or restoration option, gives the optionee a
new stock option after an existing option has been exercised, typically by tendering or attest-
ing to the ownership of company stock. Option reloads act like a stop-gain order, capturing
profits on the full-value grant and receiving a new option on the equivalent of shares
tendered. The new options are granted at current FMV (but could be at a discounted price
to make them more appealing) and typically run for the remaining term of the option
exercised, while carrying the vesting requirements from the original grant date. This addresses
the disadvantage identified in Table 8-25 (i.e., the “lost” 625 shares). This is highlighted in
Table 8-24. Note that the two disadvantages identified in the stock-for-stock exercise in
Table 8-25 have been eliminated. More specifically, the number of shares “at work” is
unchanged (i.e., it is again 1,625), and ownership of stock is promoted two ways. First, the
optionee needs to own stock and use it to exercise the grant and second, early exercise is
encouraged because it will mean a longer exercise period for the second grant.

• Optionee has 625 options.
• Option price is $160 per share.
• Cost to exercise is $100,000.
• Grant expires date of original grant.
• Optionee owns 1,000 shares.
• Current market price of the stock is $160.
• Current market value of shares owned is $160,000 (1,000 $160).
• Number of shares “at work” is 1,625.
Table 8-24. Example showing status before a stock-for-stock exercise

Should the terms of the option be amended to add a reload feature, both FASB and the
SEC will regard the reload as a new grant, not a continuation of the underlying grant. In this
situation FASB ruled that variable-award accounting rules apply and that a charge to
earnings must be taken for the difference in price. However, in 2000, FASB also stated that