Page 505 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 491

For Plan Period Years in Grade Target Payment
31 33 31 33 Prorated

1–4 3 1 6,000 8,000 6,500
2–5 2 2 6,000 8,000 7,000
3–6 1 3 6,000 8,000 7,500
4–7 0 4 8,000 8,000
Table 8-73. Prorating a promotion

In a similar manner, a new hire would be granted a prorated award. In the above example,
assume the person was hired directly into grade 33, essentially joining the company at the end
of year three. Therefore, the target would be 2,000 (one-fourth of 8,000).
Plan Period. Most stock options are for 10 years since that is the maximum permitted for
statutory stock options, and nonqualified options are often granted at the same time.
However, because of an extensive charge to earnings for stock options, a company might opt
for a shorter period (e.g., five or seven years). Stock appreciation rights are typically for
the same period of the underlying stock option or, more commonly, for the option they
are replacing (typically, in international situations because of local tax-law restrictions on
company stock).
Stock award plans are usually half the duration of options or less. Performance-share
and unit plans (as well as percentage-cash plans) are typically three to five years in length. A
capital-intensive company might opt for the longer period to allow time to achieve return
on investment. A company in a less-than-stable industry might opt for a short period. A
restricted stock award with no performance requirements is probably three to five years in
duration. A performance-based, restricted award (i.e., the earlier-described PARSAPs and
TARSAPs) are often five-year or seven-year awards, with opportunity to receive as early as
two years if stated performance requirements are met.
Award Size. The size of the long-term incentive award is based on marketplace and internal
relationships. The mantra is externally competitive and internally equitable. The stock option
section looked at different ways of valuing the stock option competitively and then develop-
ing an internal structure. The same is true with other long-term incentive plans. First, deter-
mine how much of the executive’s pay should consist of long-term incentives versus salary and
annual incentives. Next, determine the proportion of each incentive plan to total long-term
compensation. It is a rare company that has only one form of long-term incentive.
In determining award size when two or more plans are in place, make a distinction
between tandem and independent awards. With tandem awards, there are two plans and the
recipient chooses which to participate in. With independent plans, the recipient may partici-
pate in both. Tandem plans lower the downside risk associated with independent plans. A stock
award will always be more valuable than a stock option. Both have the same appreciation
opportunity; however, the stock award also has the underlying value of the stock. Therefore,
options are usually awarded in multiples of stock awards. The value of a stock option is
typically set at about one-third the current value of the stock, or a three-to-one ratio. Their
comparable values are both functions of future value. In Table 8-74, assume a 50 percent
increase in value yielding a three-to-one ratio. Below 50 percent, the stock award is more