Page 453 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 439

The reload may be attached to both statutory and nonstatutory options when granted
but only to nonstatutory options retroactively. Reloading a statutory grant will make it a
nonstatutory option.
Typically, a reload is done only once. When multiple reloads are permitted, they often
require a minimum appreciation in price appreciation and/or length of time to lapse before
they can be triggered (e.g., six months or more).
Another feature is that a company may require the optionee to hold the stock obtained on
a reload until leaving the company or for a prescribed time period (e.g., 10 years), whichever
occurs first. Some may require the optionee to have met any established stock ownership guide-
lines in order to reload an option, and/or the reload feature may expire at time of termination.
Reasons for using reloads include the following:

• They encourage stock ownership, if the reload requires tendering stock owned.
• They encourage early exercise of a reloadable stock option (to get the exercisable term
of the original grant).
• Downside risk is reduced by in-the-money exercise to get the reload.
• Dilution is reduced if tendered shares are not available for future grants.
• After-tax effectiveness is enhanced with exercise-and-hold strategy if there is a
significant difference between the ordinary and long-term capital gains tax rates.
Reasons against using reloads:

• Dilution is increased if tendered shares are available for new grants.
• Little or no spread between ordinary and long-term capital gains taxes would discour-
age the ownership required to tender stock.
• Stock ownership is not encouraged if optionee can get the reload by using cash to
exercise the option. Shareholders are likely to vote against a plan permitting reloads.
• The SEC requires proxy disclosure, giving the appearance of an additional grant.
• Reloads increase administrative work.
• Additional communication work is required to ensure that optionees as well as
shareholders understand how they work.
• The FASB requires new-grant accounting.
• Dilution is not reduced if tendered shares are available for future grants.
Stock Split. When a company makes a stock split, it must adjust the number of shares under
option accordingly. For example, if it is a two-for-one split, then the number of shares under
option should be doubled and their price halved. The net effect is that the cost to exercise
the total option is the same.

Exercising the Option

Methods. If the terms of the option are met, the optionee has a unilateral right (but not a
commitment) to buy the stock at the price stipulated. The exercise (or purchase) may be
accomplished in one of several ways as long as they are permitted by the plan. These include
paying cash, tendering company stock; and/or simultaneously buying and selling the stock
(called a cashless exercise). The first two expose the optionee to downside risk.
Cash Exercise. If cash is used, it may come from the sale of company stock (using the after-
tax proceeds) or from other sources. Once “exercised,” the stock is transferred to the