Page 530 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

516 The Complete Guide to Executive Compensation

1,000,000
Stock
Options
750,000
Performance
Share
$ Value 500,000 Performance

Unit

250,000

0
$50 $100 $150
Stock Price
Figure 8-8. Value comparison of stock option, performance share, and performance unit
change in price-earnings multiple and a constant increase in earnings per share of 10 percent.
However, everyone is familiar with the problems in assuming such a constant relationship.
As shown in Figure 8-8, the stock option is the most highly leveraged form—worthless below
$50 a share and worth $1 million at $150 a share [10,000 ($150 $50)]. Conversely, the
performance unit has no leverage; the number of shares awarded is adjusted inversely in
relation to market direction. The performance-share plan is between the two.
Combining plans essentially eliminates the negative aspects. For example, by targeting
the performance-unit fund at $500,000 for 100 percent attainment of objectives and giving
the individual an option for 10,000 shares at $50, we have (1) avoided accrual for increases
beyond $50 a share, and (2) given the executive the opportunity to participate in the growth
of company stock price. Following this approach, the chart values would be additive. In other
words, assuming 100 percent attainment of target and stock price at $100, the performance-
unit plan would generate $500,000, and the stock option gain would be $500,000. This is the
equivalent of having given the executive 10,000 performance shares; however, in this case the
charge to earnings is one-half that required by the performance-share plan (i.e., $500,000,
not $1 million).
Table 8-94 shows a stock-option-only (old plan) vs. a combination stock option and
performance-share plan (new plan). Note that the stock options were halved and the remain-
ing half was put into performance shares. Remember the guideline of one stock award for
every three shares of stock option? A price of $100 a share was used in the example. Note that
if the stock price were to double, the old plan is better. At a 50 percent increase, the two are
comparable, and below that, the new plan is better. This assumes the stock award and stock
option are for comparable periods. If not, the calculations have to be adjusted. Additionally,
if the award is at “target” but a maximum award of twice as much is possible, this should also
be calculated.
One could also create a dependent market-based plan. For example, one could grant a
number of restricted shares of stock along with a stock option. The award might be at time