Page 468 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

454 The Complete Guide to Executive Compensation

Grant Vest Exercise Sell

Time Lapse Today Three years Five years Eight years
Stock price
• Fair market value $100 $130 $160 $210
• Option price $105 $105 $105 $105
Individual
• Ordinary income — — $55 —
• Long-term capital gains — — — $50

Company
• Tax deduction — — $55 —
• Expense* — $28 — —
* Accrued over period of vesting
Table 8-34. Nonstatutory, single-priced premium stock option

A multiple-priced premium nonstatutory stock option with the future prices (an increase of
$5 a year) fixed at the date of grant is illustrated in Table 8-35. The spread between fair
market value and option price at time of exercise ($35) is income to the individual, with a like
amount as tax deduction to the company. Three years later, having met the holding require-
ments for long-term capital gains, the individual has a favorable tax rate on $50 of income
(i.e., $210 $160). Given the different option prices at which the grant could be exercised,
it could be argued the best option pricing model would be the bionomial lattice model. The
example assumes a cost of $21 accrued over the vesting period.

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 $105 $125 $125
Individual
• Ordinary income — — $35 —
• Long-term capital gains — — — $50

Company
• Tax deduction — — $35 —
• Expense* — $21 — —

* Accrued over period of vesting
Table 8-35. Nonstatutory, multiple-priced premium stock option

In Table 8-36, we have a nonstatutory index stock option. In this example, the option prices
to be the same as shown for a multiple-priced premium option in Table 8-35, except the