Page 509 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 495

In this example, the company is awaiting shareholder approval on a proposal for an addi-
tional 15 million shares, or 4.6 percent of shares outstanding. The authorized shares are
included in this review in case the company is considering a stock split. It has enough for a
two-for-one split and is just short of that needed for a three-for-one split (i.e., 325,000,000
20,000,000 10,235,000 355,235,000), since the 1,065,705 required (i.e., 355,235,000
3) exceeds the 1 billion shares authorized.
Let’s take the analysis one step further. In Table 8-78, the company has estimated the
number of shares it will need for the next five years, based on its stock option plan and a
performance-share plan. The performance-share plan is shown at the maximum-value
number to be safe. The target would be one-half that amount.

Stock Options Performance Share Total
Year 1 1,500,000 1,000,000 2,500,000
Year 2 1,500,000 1,000,000 2,500,000
Year 3 1,500,000 1,000,000 2,500,000
Year 4 1,500,000 1,000,000 2,500,000
Year 4 1,500,000 1,000,000 2,500,000

Total 7,500,000 5,000,000 12,500,000
Table 8-78. Estimated number of shares needed for plans

The 12.5 million shares is well within the 15 million shares requested, so the company will
not have to return to the shareholders for at least five years, longer if the performance-share
plan pays out below the maximum. This example assumes a static number of participants and
awards for each of the five years. A more detailed examination would estimate changes in the
number of eligible candidates and their awards by year.
Dilution is always a shareholder concern. An increase in the number of shares outstanding
dilutes earnings per share and may therefore affect stock price. In the Table 8-77 example, the
current dilution is 3.1 percent, but the total dilution is 9.9 percent. Some call this additional
6.8 percent the overhang or future overhang. Others refer to the 9.9 percent as the total potential
overhang or total future overhang. Under FAS 128, EPS (earnings per share) is simply earnings
divided by shares outstanding. Diluted EPS is also calculated using FAS 128 earnings per share
(replacing APB Opinion 15).
This standard requires the treasury stock method to determine the increased number of
shares in the denominator resulting from outstanding options that are “in the money” (i.e.,
market price exceeds option price). More specifically, the cost to exercise in-the-money
options is used to buy back as many shares as possible, based on current market price. Using
the data in Table 8-77, assume the average option price is $60 a share (and all of the
10,235,000 options outstanding are in the money). Further assume a current fair market
value of $100. The calculation would be as follows:

10,235,000 $60 $614,100,000
$614,100,000 $100 6,141,000 shares
10,235,000 6,141,000 4,094,000 shares added to the denominator