Page 534 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

520 The Complete Guide to Executive Compensation

assume that the company plans on maintaining a dividend policy equaling 37.5 percent of
earnings per share. The estimates of EPS, dividends, retained earnings, and book value for the
time period are reported in Table 8-97. Note that the common share stock price has also been
increased on the same progression (retaining its 10 times price-earnings multiple).

Allocation of EPS
Book Value Common
EPS Dividend Retained Book Value Plus EPS Stock Price
Base — — $25.00 $25.00 $36.00
1 $4.00 $1.50 2.50 27.50 29.00 40.00
2 4.40 1.65 2.75 30.25 33.40 44.00
3 4.84 1.81 3.03 33.28 38.24 48.40
4 5.32 2.00 3.32 36.60 43.56 53.20
5 5.86 2.20 3.66 40.26 49.42 58.60
6 6.44 2.41 4.03 44.29 55.86 64.40
7 7.09 2.66 4.43 48.72 62.95 70.90
8 7.79 2.92 4.87 53.59 70.74 77.90
9 8.57 3.21 5.36 58.95 79.31 85.70
10 9.43 3.54 3.89 64.84 88.74 94.30
Total $63.74 $23.90 $39.84

Appreciation $39.84 $63.74 $58.30
Table 8-97. Ten-year projection of book value and stock price

Assume that it is decided that the executive should receive an award whose estimated
appreciation 10 years hence should be worth $500,000. If a nonqualified, market value option
were to be given, it would probably be for about 22,400 shares [i.e., $500,000 ($58.30
$36)]. However, the same value could be extended by giving appreciation rights on about
33,700 shares of book value [i.e., $500,000 ($39.84 $25)], or 12,900 shares of book value
plus dividends [i.e., $500,000 ($63.74 $25)]. The advantage of excluding dividends from
the calculation is that any change in the dividend payout has an adverse effect on the increase
in book value plus dividends.
Rather than simply use one of the three approaches, a combination plan can be set up
using either a tandem or parallel approach as shown in Table 8-98. Under the parallel
approach, each action is self-standing and unaffected by any other actions. Although any
desired relationship can be set, a logical choice might be that half of the estimated $500,000
value should be attained from the market price and the other half from book value. Thus, the
number of shares available for an independent or separate action is reduced by half, as shown
on the grid. Under the A plan, the executive would receive 11,200 option shares for common
stock at $36 a share and appreciation on 16,850 shares of book value at $25. Under the B
plan, the executive would receive 6,450 appreciation units on book value (defined to include
dividends) plus an 11,200-share nonqualified, market value option.