Page 467 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 453

Grant Vest Exercise Sell

Time Lapse Today Three years Five years Eight years
Stock price
• Fair market value $100 $130 $160 $210
• Option price $100 $100 $100 $100

Individual
• Ordinary income — — $60 —
• Long-term capital gains — — — $50

Company
• Tax deduction — — $60 —
• Expense* — $30 — —
* Accrued over vesting period
Table 8-32. Nonstatutory, nondiscounted stock option

Grant Vest Exercise Sell

Time Lapse Today Three years Five years Eight years
Stock price
• Fair market value $100 $130 $160 $210
• Option price $90 $90 $90 $90
Individual
• Ordinary income $12 — $60 —
• Long-term capital gains — — — $50

Company
• Tax deduction $10 — $60 —
• Expense* — $33 — —
* Accrued over vesting period
Table 8-33. Nonstatutory, discounted stock option

best price. Typically this would be given for a company in the mature or decline stage of the
market cycle. Fair-value accounting might best be determined by a binomial lattice formula.
A premium-priced, nonstatutory stock option with the price (e.g., $105) set at date of grant is
illustrated in Table 8-34. If the option pricing model came up with a fair value of $28, it
would be this amount that would be spread equally over the vesting period of three years.
The spread between fair market value and option cost at time of exercise ($55) is income to
the individual, with a like amount as tax deduction to the company. Having met the holding
requirements for long-term capital gains, the individual has a favorable tax rate on $50 of
income.