Page 510 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

496 The Complete Guide to Executive Compensation

Some believe it appropriate to go beyond the FAS 128 requirement and use the cash
value of any tax deductions as well. For example, were all the stock options nonqualified,
there would be a tax deduction of $409,400,000 (i.e., $40 10,235,000 shares). If the corpo-
rate tax rate were 35 percent, this would generate an additional cash flow of $143,290,000
(i.e., .35 $409,400,000). At a cost of $100 a share, the company could buy back an a
dditional 1,432,900 shares, reducing the increase in the denominator to 2,661,100 (i.e.,
4,094,000 1,432,900).
A more appropriate way to measure dilution may be to assume the option price (i.e., strike
price) and the tax value of the deduction (if any) is used to repurchase shares on the market.
In this way, only the incremental number or shares (i.e., those not repurchased) dilute out-
standing shares. Some companies do exactly this, as there is no associated expense; however,
the company does lose the positive cash flow of the option proceeds and tax deductions.
Market capitalization, or market cap for short, is nothing more than current stock price
multiplied by the number of shares outstanding. In Table 8-77, assuming $100 a share, the
market cap is 32.5 billion. By any standards, this is a large cap, if not a mega-cap. Although
definitions vary, market cap can be broken into parts: micro-cap (under $100 million), small-cap
(between $100 million and 1 billion), mid-cap (between $1 billion and $10 billion), large-cap
(between $10 billion and $100 billion), and mega-cap (above $100 billion).
The Formal Stock Plan. A formal stock plan consists of two slightly different documents.
The first is a document typically prepared for shareholder approval and referred to here as
the formal plan or the shareholder plan. It authorizes management to use company stock as
a form of compensation within the limits prescribed by the plan. Various overseers may
mandate such a document including the SEC, the state in which incorporated, and/or
the listing stock exchange. It may also be needed to take advantage of the tax deduction
requirements of Section 162(m) or 412 of the Internal Revenue Code. The second document
is created for the executive and is referred to here as the executive plan. This document is
typically approved by the compensation committee of the board and specifies the terms
and conditions of the stock award/option. Each is a formal contract: one with shareholders
and the other with the executive. Let’s examine the contents of both, as well as some design
considerations.
Purpose. The formal plan will typically state its purpose as being to effectively attract, retain,
and compensate key employees to ensure company success and provide a reasonable return
on shareholder investment. The executive plan (typically in the form of a letter) may repeat
this and go further. If it includes a stock option, the letter will indicate the opportunity to
share in the future growth of the stock price (hopefully, the result of the collective efforts of
key employees). If it includes a time-based stock award, the letter will talk of the value of
providing future pay (with the hidden message that the executive must stay around to cash
in). If it includes a performance-based stock award, the nature of such performance will be
described (e.g., financial or shareholder).
Definitions. Both documents will identify and describe key words used in each plan. The
shareholder plan will be broader in scope since it covers all plans. However, it will not go
in-depth into any one plan like the executive plan, which will be more detailed in nature and
may include material covered in this chapter.
Administration. The formal plan will identify the respective responsibilities of the board of
directors and its compensation committee in setting up rules and administering the plan. It may