Page 480 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

466 The Complete Guide to Executive Compensation

Variable VCFBF VCVBP
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Fixed FCFBP FCVBP

Fixed Variable
Basis for Payment
Figure 8-4. Types of stock purchase plans
period of years, the executive can cancel the loan balance by returning to the company the
number of shares whose market value equals the loan balance plus any unpaid interest.
Should the executive leave the company, typically such loans are required to be paid in full
immediately (although a forgiveness clause might be structured in the event of the executive’s
death). The company may also choose to forgive the interest if the stock acquired is retained
for a specified period of time.
Since the executive will have income at time of purchase equal to the difference between
purchase price and fair market value, it is desirable from the executive’s point of view to
immediately purchase all the shares (when this difference is little or nothing) through a loan
arrangement. However, the company must be careful to ensure that the Federal Reserve
margin requirements are followed when shares are used as collateral.
If the purchase price is discounted, the stock is typically given to the executive with a
number of restrictions regarding disposition. The discount may be a stated percentage
(e.g., 50 percent) or a stated value (e.g., par or book value). Discounted stock purchase
plans are designed to ease financing (by lowering the cost) and minimize the negative impact
of a subsequent drop in market price (by setting the purchase price significantly below
market value).
Restrictions are placed on the executive to minimize temptations to sell the stock prema-
turely for a quick profit. Restrictions also affect tax treatment since the company deduction
and executive’s income are both deferred until the restrictions lapse, assuming the restrictions
satisfy the “risk of forfeiture” requirement of the IRS to avoid current taxation. Such restric-
tions lapse in installments (e.g., 10 percent a year for 10 years) or a cliff all-or-nothing (e.g.,
100 percent after five years but zero vesting before then). While the restrictions are in effect,
the shares of stock affected generate dividends, which are taxable to the individual but
probably tax deductible to the company. The company must recognize the discount value as
a charge to the earnings statement based on a fair-value equity pricing model.
Table 8-46 shows an example of an FCFBP plan. The stock is offered at a 10 percent
discount with a five-year cliff vest. Since the stock is under restriction and must be sold back
to the company at $90 a share if the executive leaves before the stock is vested, there is no
income recognition by the individual until the vesting date (or termination date, if sooner).
Similarly, the company has no tax deduction until that date. However, the company must
begin to accrue a charge to earnings over the five-year vesting period based on the option
pricing model. At the time the stock vests, it is selling at $160 a share. The individual has $70
of income, and the company a like deduction. Two years later, the executive sells the stock