Stock Compensations Plans
APB Opinion 25
FAS 123
Stock Compensations Plans
• Non compensatory Plans
– Substantially all employees participate
– Discount from market price is small
• Issue cost
5%
– No substantive option feature
• Goal is to raise capital, thwart takeover by
putting stock in friendly hands
Stock Compensations Plans
• Effective compensation Plans:
– Motivate employees to high level of
performance
– Help retain talent
– Helps in recruiting talent
– Minimize employer after tax cost
– Maximize employee after tax benefit
– Goal congruence tied to compensation
Stock Compensations Plans
• What is the value of the Compensation?
– Intrinsic value No Longer GAAP
• Market price –Exercise price at date of Grant
• Both the number of shares and option price is
known
– Fair value Method
• Fair value of options expected to vest on the date
of grant
– Black Scholes method
– Binomial method
Conceptual Issues
• Measuring compensation expense at date
of grant is more reliable (grant price and
stated option price is known) but not
relevant. The fair value of the option is
more relevant.
• Intrinsic value
– Overstated income
– Overstated ROE, ROI
Fair Value Measurement
• Should fair value be:
– The value of the services received from the
executive?
– The value of the option given to the executive
as compensation
– Remember non-monetary exchange – Which
value is more reliable?
Political Controversy
• 1800 letters of comments
• Big corporations supported high-tech
start-ups to maintain status quo
• Bills were introduced in congress to outlaw
the method– congress setting accounting
standards on the basis of politics not
conceptual framework.
• FAS 123 allowed Intrinsic or fair value.
FASB accepted political reality
Option Pricing Model
• Factors
– Exercise price
– Life of option
– Market price of related stock
– Volatility of stock
– Expected dividends
– Risk free return over life of option
Option Pricing Model
• O =M – (E/(1+i)^n)
• Where
– O = option price
– M market price on date of grant
– E is the exercise price
– i is the risk free return over life of stock
– n is number of years until option expires
Stock Compensations Plans
• Allocation Expense
– Allocated over the service period
– Service period is often the vesting period
• Fixed option share plan ( cliff vesting)
– All terms are fixed at date of grant
• Variable option share plan ( Performance)
– Future variable determine options granted
– % sales increase, % market share increase
• Stock appreciation rights
Stock Compensations Plans
•
•
•
•
•
•
•
•
Assume:
1-1-07
9000 options granted
10 year life, 30 employees
Market price $50 = option price of $50
Service period 3 years
Initial TO estimate 3%, then 6% entire period
7500 option vest, 1500 forfeited = 9000
Estimated Compensation Expense
• Fair value of option X Number of options granted X retention rate
• 2007-----$17.15 X (9,000 X .97 x .97 x .97) = 140,871
• 2008 ----$17.15 X (9,000 X .94 x .94 x .94) = 128,201
• 2009 ----$17.15 x 7,500 vested = 128,625
Fixed Compensatory Plan
Estimated total Compensation
FV option x # options X retention
rate
140,871
128,201
128,625
Fraction Expired
1/3
2/3
3/3
Estimated Compensation to date
46,957
85,467
128,625
Previously recognized
46,957+ 38,510 = 85,467
(0)
(46,925)
(85,467)
Current compensation expense
46,957
38,510
43,158
Stock Compensations Plans
Compensation Expense , 2007
46,957
Paid In capital Stock Options or
Common stock options warrants
Compensation Expense , 2008
Paid In capital Stock Options or
Common stock options warrants
$46,957
38,510
38,510
Stock Compensations Plans
Cash 300 options * $50
15,000
Common Stock Option warrants
300 x 17.15 (fv of option original credit)
5,145
Common stock par 300 8 $10
3,000
Paid in capital common stock
17,145
Cash plus service = equity credit
Stock Compensations Plans
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•
•
•
Assume:
1-1-07
9000 options granted
10 year life, 30 employees, max = 300 shares
– Market share >=5% 100 shares
– Market share >=10% 200 shares
– Market share >=15% 300 shares
•
•
•
•
Market price $50 = option price of $50
Service period 3 years
Initial TO estimate 3%, then 6% entire period
25 employees vest, 5 forfeited = 30
Estimated Compensation Expense
• Fair value of option X Number of options granted X retention rate
• 2007-----$17.15 X ((200x30) X .97 x .97 x .97) X = 93,914
– 200 options based on estimate of 12% market share
• 2008 ----$17.15 X ((200x30) X .94 x .94 x .94) = 85,467
• 2009 ----$17.15 x (300x25) = 128,625
Fixed Compensatory Plan
Estimated total Compensation
FV option x # options X retention
rate
93,914
85,467
128,625
Fraction Expired
1/3
2/3
3/3
Estimated Compensation to date
31,305
56,978
128,625
Previously recognized
46,957+ 38,510 = 85,467
( 0)
(31,305)
(56,978)
Current compensation expense
31,305
25,673
71,647
Stock Compensations Plans
Compensation Expense , 2007
31,305
Paid In capital Stock Options or
Common stock options warrants
Compensation Expense , 2008
Paid In capital Stock Options or
Common stock options warrants
31,305
25,673
25,673
Stock Compensations Plans
Employee fails to Satisfy Service requirement
Paid in Capital Stock Option
Compensation Expense
Compensation expenses is not credited
just because employee fails to exercise
option (forfeits option)
40, 000
40,000
Stock Compensations Plans
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•
•
•
Stock Appreciation Rights
No need to borrow money to exercise right
Compensation =
Market price – pre-established price *
number of rights * ( cum years/ total
service years)
• Liability accounts is credited
Stock Appreciation Rights
Date
FV per
SAR
Estimate %
Expense Accrued Annual
Comp
Accrued To
Comp
Expense
Expense
date
Exp
/Payable
12-31-06
20
20,000
1000x20
25
5,000
0
5,000
12-31-07
30
30,000
50
15,000
5,000
10,000
12-31-08
18
18,000
75
13,500
15,000
(1,500)
12-31-09
26
26,000
100
26,000
13,500
12,500
12-31-09
34=
34,000
100
34,000
26,000
8,000
QMP-Opt
price
Dr
SARpayable