Page 459 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 445

constructive receipt issues, selects an exercise date more than six months in the future. In addi-
tion, the optionee selects a subsequent future date when the shares should be delivered (and
the taxable event recognized). Assume at that time the FMV is $210 a share, thus resulting in
income of $41,250 (i.e., $110 appreciation on 375 shares).
Key points to remember in designing this feature include the following: FAS 123R
considers a reload a new grant; unfunded share units rather than actual shares to avoid
current taxation issues; be certain exercise action is set for a date more than six months in the
future while an active employee and that it is in conformance with Section 409A of the
Internal Revenue Code.
Permission to elect a deferral could be accomplished by permitting the action in the stock
plan and/or by establishing an unfunded, executive-deferral plan that permits the deferral of
stock option exercise gains. While it may be best to do both, certainly the appropriate
deferred-compensation plan should be in place. Nonetheless, the gain at time of exercise is
probably subject to FICA, FUTA, and most importantly (because of no earnings cutoff)
Medicare (IRC Section 3121).
With the six-month advance notice requirement, the transaction probably avoids SEC
Section 16 issues. However, some may argue that the spread at time of deferral should be
taken as a charge to earnings. This is questionable if only mature shares are used to exercise
the grant and the deferred shares from the exercise are converted to units and paid in actual
shares at some future date (such as retirement or other termination). The Emerging Issues
Task Force stated in EITF Issue No. 97-5 that making an election at least six months before
exercise to defer the option gain will not involve additional company expense. A new
measurement date is not required unless the deferral is converted into something other than
company stock; then it is treated as if it were a cash SAR.
These three methods (cash, stock-for-stock, and cashless) are compared and contrasted
in Table 8-29. In this example, the current stock price is $160 a share and the option price is
$100 a share. One can see that before the exercise, the optionee had 1,625 shares “at work”
(625 owned and 1,000 under option).

Executive Stock Status After Exercising the Option

Exercise Methods
Before Exercise Share Status Cash Stock Cashless

625 Shares owned 1,625 1,000 625
1,000 Under option — — —

1,625 Total at work 1,625 1,000 625
Executive and Company Cash Status After Exercising the Option
Executive ($100,000) — $60,000

Company $100,000 — $100,000

Increase in Outstanding Shares 625 375 1,000
Table 8-29. Contrasting the exercise methods