Page 469 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)
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Chapter 8. Long-Term Incentives 455
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 8-36. Nonstatutory, index-priced option
future prices were not known at time of grant—only the method for determining those prices
over the period of the grant namely a specified external index such as the Dow Jones
Industrial Average or the S&P 500. As an equity award it is eligible for grant date account-
ing using an option pricing model, perhaps an open model such as the bionmial lattice for-
mula due to time and date unknowns As a market condition plan the charge can not be adjust-
ed downward for failing performan. Typically the index is used to set a higher price, but it
could be used as an inverse measurement to set a lower price. This is called a yo-yo option.
It encourages later exercising in a rising market. It is most likely to be used in a mature stage,
if used at all.
Vesting-Determined Stock Options. The most common vesting is the time-only requirement,
either cliff (e.g., three years) or installment (e.g., 25 percent a year). All of the examples in
the previous section were time-only vesting.
A performance-accelerated stock option has two parts—time and performance. The time
portion might be cliff vesting after seven years. The performance feature enables earlier
vesting, typically as soon as three years. For example, the company may indicate the option
is cliff vested after seven years or when the company achieves a compound increase in cash
flow from operations of 10 percent over a three-year period. This could be achieved after the
third year, fourth, fifth, or so on. If not achieved by the seventh year, it would be vested by
time. Because this is an equity award, the fair value is determined at time of grant using either
an open or closed option pricing model.
A performance-vested, nonstatutory stock option is highlighted in Table 8-37. In this example,
it is similar to a nondiscounted option as shown in Table 8-32. The only difference is that
vesting is dependent on attaining prescribed financial goals (e.g., stock price or earnings
per share). Although the number of shares is not known at time of grant (and the option
cannot be exercised if they are not met), since settlement is in shares of stock, the option is
considered an equity award subject to fair-value accounting at date of grant using a fair-value
model. Again, because of various possibilities, an open model may be more appropriate than a
closed model.