Page 474 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)
P. 474

460               The Complete Guide to Executive Compensation


            Company
            Advantages                          Statutory (ISOs)  Nonstatutory (All Others)
            Positive cash flow from exercise proceeds  True                True
            Positive cash flow from tax at exercise  False                 True
            Positive cash flow from tax at sale
              if not LTCG                            True                  True
            No outlay of cash                        True                  True
            Fixed accounting at time of grant        True                  True
            Disadvantages

            Increased dilution with shares purchased  True                 True
            Fair-value expense over vesting period
              reduces profits                        True                  True
            No tax deduction if optionee meets
              holding requirements                   True                  False
            Executive may leave if stock price does not
              exceed option price                    True                  True
            Table 8-41. Stock option advantages and disadvantages to the company


            parachute (either single or double trigger). When activated, it would immediately convert all
            of the stock option gains to cash SAR payouts.
               SARs can also be freestanding, namely, not connected in any way to a stock option. Self-
            standing, or freestanding, SARs are really phantom awards, since there is no accompanying
            stock option. Such a plan must be designed carefully to avoid an IRS ruling of constructive
            receipt due to lack of alternative right. An important point to remember in structuring a
            plan to avoid constructive receipt is the basic principle that if income is available only if the
            individual forfeits a valuable right, then income is subject to a substantial limitation and not
            constructively received. In Revenue Ruling 80-300, the IRS, applying this logic, indicated
            that since the exercise of the SAR would mean the loss of valuable right (namely, the chance
            for further appreciation in the market price), the gain should not be recognized as income
            until the rights are exercised. Thus, the normal tax treatment of a SAR is to tax when
            exercised, and the company has a tax deduction in the same amount.
               As for the SEC, the grant of a SAR, like that of a stock option, is considered the
            acquisition date for purposes of the six-months rule. Initially, the SEC viewed the receipt
            of cash in lieu of stock as a simultaneous purchase and sale and therefore a prohibited
            transaction with all gains forfeitable to the company. After further reflection, the SEC
            agreed to permit the payment in cash provided certain rules were met. These include
            the following:

             1. The SAR must be administered by a disinterested board of directors or by a committee
               of three or more disinterested persons.
             2. The SAR cannot be exercisable for the first six months.
             3. The SAR can be exercisable only between the third and twelfth business days following
               the release of quarterly company earnings data.
   469   470   471   472   473   474   475   476   477   478   479