Page 531 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 517

Old Plan New Plan
Stock Price Option of Option of Award of Total Variance
Change 6,000 3,000 1,000
100% $600 $300 $200 $500 $100

50% 300 150 150 300 0
25% 150 75 125 200 (50)

0% 0 0 100 100 (100)
25% 0 0 75 75 (75)

50% 0 0 50 50 (50)
Table 8-94. Plan comparisons (option only vs. option and performance shares); dollars
in thousands
of stock option grant or at time of stock option exercise. Restrictions would lapse in
accordance with a stated retention period before the exercised options could be sold. Often,
this is called an exercise-and-hold option, or a combination option and award. This is illustrated
in Table 8-95. The objective of this type of combination plan is, of course, to motivate the
executive to exercise (buy) and not sell the stock. The cost to the company is additional
expense and increased dilution.

Assumptions
• Optionee receives 1,000 options at $100 a share.
• Options vest at the rate of 20 percent a year, fully vested after five years.
• At time of exercise, optionee will receive one restricted share of stock for every ten options
exercised.
Actions
• Two years after the grant, optionee exercises 400 shares and receives 40 shares of stock, restricted
for five years.
• Three years after exercise, the optionee sells 200 shares at $125 a share, thereby reducing the
number of restricted shares to 20.
• Five years after the grant, having held the 200 exercised shares, the optionee receives the 20 shares,
no longer with restrictions.The optionee also exercises the remaining 600 options and receives
60 new restricted shares, again restricted for a five-year period.The fair market value is now $175.
• The company has a charge to earnings for the restricted stock under variable accounting of $3,500
(20 $175) over the five-year period plus an accrual begun on $10,500 (60 $175).
Table 8-95. Exercise-and-hold example

Some companies granted both qualified and nonqualified stock options to executives. If
each option were self-standing (i.e., not affected by the other), it would be a parallel stock
option grant. If the exercise of one reduced the number of shares exercisable under the other,
it would be a tandem stock option grant.