Page 479 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 465

Company
Stock Appreciation Rights
Advantages Settled in Stock Settled in Cash
No cash outlays True False
Less dilution than stock option True True
No dilution False True
Positive cash flow from tax deduction True True
No more costly than stock option True False
Disadvantages

Increased dilution True False
Liability accrual accounting False True
Outlay of cash False True
Executive may leave if stock price
does not exceed option price True True
Table 8-45. Stock appreciation right advantages and disadvantages to the company

the stock. While the stock option may allow up to 10 years, the purchase plan typically allows
a month or two. However, a stock option could be added to a stock purchase plan. Since these
plans typically involve a company loan, it should be remembered that such loans cannot be
made to insiders under the Sarbanes-Oxley Act. However, a third-party loan without any
company involvement should be permissible.
The executive stock purchase plan should not be confused with the tax-qualified
purchase plans described in Chapter 6 (“Employee Benefits and Perquisites”). Those plans
require nearly all employees to participate and allow up to five years for the individual to pur-
chase stock as low as 85 percent of market value (determined either at time of offer or time
of purchase, depending on the structure of the plan). Such plans are developed in accordance
with Section 423 of the Internal Revenue Code and must be nondiscriminatory in participa-
tion. Executive stock purchase plans are much more flexible in design and limited in partici-
pation. Executive plans can be described in terms of the basis for determining cost of the
shares and the basis for payment. Since each can be either fixed or variable in nature, four
possible combinations result: (1) fixed cost and fixed basis for payment, (2) fixed cost and vari-
able basis for payment, (3) variable cost and fixed basis for payment, and (4) variable cost and
variable basis for payment. These are illustrated in Figure 8-4.

Fixed Cost and Fixed Basis for Payment (FCFBP). The cost might either be at or below
market value of the stock at the time the offer is made; the basis for payment is a specified
yearly schedule that will pay for the stock over a stated period of years or in a lump-sum
payment at the end of a defined period. Such arrangements are attractive because typically
the company gives the executive a low-interest or no-interest loan to purchase the stock
(see Chapter 6). Ideally, the executive’s annual bonus is sufficient to meet the loan repayment
amount. However, since the bonus is of course taxable, this would suggest that a $100,000
bonus is necessary to retire $50,000 of the loan in a given year (assuming a 50 percent
marginal tax rate). In addition, it may be appropriate to structure the loan so that after a