Page 477 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 463

the plan and in conformance with SEC requirements). The corporation would have a deduc-
tion for $60,000, and the executive would have a tax liability for a comparable amount of
income. The company would also have a $30,000 charge to earnings (see Table 8-32). If the
plan permitted, (1) 375 shares, not 1,000, would have been charged against any plan maxi-
mum in effect per participant, and (2) 625 shares, the difference between 1,000 and 375,
would have been returned to the plan for future grants. Note that the executive ends in
the same position (an additional 375 shares) as if a stock-for-stock exercise had been done
(see Table 8-25).

A Closer Look at Accounting and Tax Treatment of SARs. Using the earlier example of
SARs attached to a grant of 1,000 options at $100 a share, exercise as SARs when the price is
$160 a share will result in taxable income to the individual of $60 a share, the company
having a like deduction in taxes. Under FAS 123R, if the settlement is in stock, the SAR will
be considered an equity award with fair value determined at date of grant and expensed over
the vesting period. In this example, the charge is $30 spread equally over the 12 quarters of
the three years of vesting. Note this is the same as the treatment of a nondiscounted stock
option illustrated in Table 8-32. If the SAR is to be settled in cash, it will be considered a
liability award and the expense accrued over the period until exercise date. In this example,
this would be $60. This is illustrated in Table 8-43.

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 $60 —

* Accrued over period of vesting or until exercise, depending on settlement form
Table 8-43. Stock appreciation right

Why SARs? SARs are most attractive in times of high interest rates and low stock price
appreciation and were created at a time when insiders had to wait six months after exercising
an option before they could sell the acquired stock. When the SEC decided that the grant
date, not the exercise date, constituted the purchase date, executives had to wait only six
months after grant to exercise and sell the stock without having a short-swing profit problem.
Since virtually no grants were exercisable sooner than one year after grant, SARs were no
longer needed.