Page 553 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 9. Design and Communication Considerations 539

in stock price but also based on degree of attaining prescribed financial targets. The
performance-unit plan (PUP) is a cash-based PSP. Stock price has no impact.
6. Requires no special target setting. Stock options require no target setting (only the
number of shares to be granted), whereas PSPs and PUPs require internal targets to
determine unit of payment.
8. Has fixed expense charge to earnings. Because stock options and performance-
share plans are stock-settled awards under FAS 123R, their fair value is determined at
time of grant. A performance-unit plan settled in cash is considered a liability award
under FAS 123R and is subject to variable accounting.
10. Is tax deductible to company. Unless the optionee does not meet the holding
requirements (i.e., makes a disqualifying disposition), there is no tax deduction with an
ISO. Conversely, with the NQ stock option, the full value of the gain is tax deductible.
With the PSP and PUP, the total of the payout is the deductible.
11. Is not taxable to the individual. Stock (under an NQ or PSP) or cash (under a
PUP) is 100 percent taxable as ordinary income when received. With an ISO
(assuming holding requirements are met), there is no tax upon receipt (except for
possible alternative minimum tax), and long-term capital gains tax will ap ply to gain
at time of sale.
Company B

4. Correlates with corporate performance. With stock options, the linkage between
stock price and corporate performance is not as direct as many would like, whereas
with PUPs, payout is based solely on attainment of corporate performance. PSPs are
a combination of corporate performance and stock price.
7. Ties high performer to company. Stock options that may be fully exercisable in one
or two years have some retention value, although it is stronger if vesting occurs after
five years. PSPs and PUPs typically are three- to five-year plans with annual start-ups,
so unvested benefits exist in any given year.
9. Has no dilution to shareholder equity. Since the full payment is in company stock,
usually one needs more options than share awards to achieve comparable values.
Therefore, options receive the lowest score, while PSPs are somewhat better only
because they require fewer shares to deliver comparable value. PUPs, of course, have
no dilution if paid in cash.
13. Requires no individual investment. Both stock options require financing the cost of
the underlying stock, although the optionee can avoid this if he or she has no need to
hold the stock. PSPs and PUPs require no investment at all.
14. Individual has no downside risk to individual. Both stock options have the down-
side risk of losing all value. They are worth nothing underwater and may be worth
little after taxes in the absence of sufficient appreciation. With a PSP, there is some
downside risk since payment is in company stock (but there was no investment),
whereas with a PUP, there is no downside risk since payment is in cash.
Weighted vs. Unweighted Objectives

A variation to the unweighted identification of important objectives shown in Table 9-14
would be to give them importance weightings. Actually, Table 9-14 reflects a binary weight-
ing of one or zero, with only those objectives listed being given a one. This two-point scale