Executive Compensation
And Restricted Stock
NIRI Philadelphia
March 10, 2005
Bruce Brumberg, Editor-in-Chief
myStockOptions.com
Bruce@myStockOptions.com
617-734-1979
Copyright 2005, myStockPlan.com, Inc.
Please do not distribute or copy without permission.
The Big Changes And Opportunities

Hewitt (HR consulting firm) Total
Compensation Measurement Database:
2004 trends show the "biggest shifts
ever seen in executive compensation”
The Big Shifts Noted by Hewitt




Stock options represent 31% of the total compensation of
a Fortune 100 senior executive, down from 50% two
years ago.
Time-based restricted stock/restricted stock units are
offered by 48% of surveyed companies (up from 29% in
2002), replacing former option grants.
Performance share or performance unit plans are in place
at 50% of companies, up from 42% in 2002.
Fewer managers and director-level employees received
stock options or other forms of long-term incentives: 33%
received these awards, down from 50% in 2003. Hewitt
has not seen companies "replacing this value with other
forms of compensation."
Trends In Executive Compensation From
2004 Proxy Statements
The Changing Landscape Of Equity
Compensation And Long-Term Incentives
For Senior Executives
(data provided by Equilar)





Importance of pay that creates long-term incentives
Stock options
Restricted stock
Long-term incentive plans
Stock ownership guidelines and holding periods
2003 CEO Compensation Analysis
S&P 500 Companies
Small Cap Companies
Year Over Year
Change
2003
$6,629,958
-7.1%
$1,366,560
-5.6%
Salary
$950,000
+1.6%
$482,004
+2.1%
Bonus
$1,078,040
+18.9%
$166,360
-11.3%
Value of Stock Options
$2,769,003
-32.8%
$364,900
-28.7%
Restricted Stock
$1,978,102
+31.9%
$388,267
+35.9%
Long-Term Incentive Plan Payouts
$1,709,391
+48.6%
$301,490
+43.3%
2003
Total Direct Compensation (TDC)
Median Market Capital
$9.0BN
Year Over Year
Change
$521MM
Notes: Total Direct Compensation has been calculated for each individual CEO by summing salary + bonus + restricted stock + option
awards + LTIP payouts. The TDC number provided in this chart is the median of the TDCs for all CEOs in the study.
TDC = Salary + Bonus + Value of Option Awards + Restricted Stock + LTIP Payouts.
Small Cap Companies include 396 companies in the S&P 1500 with market capitalization under $1.0 billion.
S&P 500 CEO analysis includes 414 companies that have filed their proxy for fiscal year 2003.
Value of stock options calculated using a standardized Black-Scholes methodology.
All numbers are median values. Calculations of restricted stock and LTIP payout medians are based on those CEOs receiving such an
award or payout.
Source: Equilar Analysis
Long-Term Incentives:
S&P 500 CEO TDC
2003
2002
Restricted
Stock
9%
Restricted
Stock
15%
Salary
9%
Salary
10%
Bonus
12%
Options
51%
Bonus
17%
LTIP
4%
Options
66%
LTIP
7%
Total = $3.8BN
Total = $4.3BN
Long-Term Incentives:
Prevalence Of Long-Term Awards (S&P 500)
2003
2002
2001
Options Only
34.8%
39.6%
44.2%
Options &
Restricted Stock
19.3%
20.3%
19.8%
Options & LTIP Only
16.0%
17.1%
16.4%
All Three Awards
11.1%
7.2%
7.5%
Restricted Stock Only
5.8%
2.7%
1.0%
LTIP Only
2.4%
1.2%
2.4%
Restricted Stock &
LTIP Only
0.7%
1.4%
0.5%
None
9.9%
10.4%
8.2%
Long-Term Incentives:
Mid- and Small-Cap CEO TDC
2003
2002
Restricted
Stock
10%
Restricted
Stock
13%
Salary
17%
Options
42%
Salary
21%
Options
54%
Bonus
17%
LTIP
3%
Bonus
21%
Total = $2.2BN
LTIP
2%
Total = $2.6BN
Long-Term Incentives:
Prevalence of Long-Term Awards
(Small/Mid Cap)
2003
2002
2001
Options Only
43.4%
52.2%
54.6%
Options &
Restricted Stock
16.9%
14.1%
14.5%
Options & LTIP Only
5.3%
6.7%
6.4%
All Three Awards
3.5%
2.9%
2.5%
Restricted Stock Only
6.1%
4.8%
2.5%
LTIP Only
1.9%
0.6%
0.4%
Restricted Stock &
LTIP Only
0.9%
0.4%
0.3%
None
22.1%
18.3%
18.8%
Analysis Of Stock Option Trends
S&P500
2003
Small Cap Companies
Year Over
Year Change
2003
Year Over
Year Change
Number of Options Granted
232,608
(7.9%)
42,858
(28.6%)
Black-Scholes Value of Option
Grants
$2.7MM
(32.8%)
$364,900
(28.7%)
81.2%
(3.1%)
Percentage Receiving Options
67.1%
(6.6%)
Source: Equilar Analysis of 414 S&P500 companies and 394 S&P 1500 companies with market
capitalization under $1.0BN.
Stock Options: Performance
IBM’s recent announcement about premium-priced options.
Other examples of companies with similar plans:
Company Name
Tesoro Petroleum
Premium of Exercise Price Over Fair Market Value
55% - 133% Premium
Electronic Data Systems
30% Premium
Chubb Insurance
25% Premium
Liz Claiborne
25% Premium
Computer Associates
20% - 68% Premium
Ecolab, Inc.
18% Premium
Lennar Corp.
10% Premium
Briggs & Stratton
6% - 8% Premium
Other examples of performance hurdles built into option grants:
Becton Dickinson: adjust target # of options based on relative TSR
Level 3 Communications: outperform stock option (OSO)
Chiron: Performance-accelerated vesting based on relative TSR
Restricted Stock Analysis:
Prevalence Of Restricted Stock Awards

Steady increases in restricted stock awards over the past three
years: S&P 500 and Small/Mid Cap CEOs
Year
# of Companies
% of Total
2003
153
37.0%
2002
131
31.6%
2001
119
28.7%
Year
# of Companies
% of Total
2003
217
27.4%
2002
176
22.2%
2001
157
19.8%
Local Companies Are Using It


Comcast’s equity-based incentive compensation is in the form of stock
options and awards of restricted stock. We believe that reliance upon
these types of incentives is advantageous to Comcast because they
foster a long-term commitment by the recipients and motivate the
recipients to seek to improve the long-term market performance of the
company’s stock. In 2003, neither Mr. Brian L. Roberts nor any of the
named executive officers received any grants of restricted stock.
Proxy statement a year earlier: The Company’s equity-based
incentive compensation is in the form of stock option grants. The
Committee believes that reliance upon such incentives is advantageous
to the Company because it fosters a long-term commitment by the
recipients to the Company and motivates these individuals to seek to
improve the long-term market performance of the Company’s stock.
Restricted Stock Analysis:
CEO Stock Grant Values
The value of individual stock grants grew significantly in 2003:
S&P 500 and Small/Mid-Cap CEOs
Year
Median Value
25th Percentile
75th Percentile
2003
$1,978,102
$1,000,288
$4,200,900
2002
$1,500,000
$685,644
$3,840,295
2001
$1,818,413
$967,478
$3,324,351
Year
Median Value
25th Percentile
75th Percentile
2003
$538,496
$268,200
$1,287,200
2002
$419,163
$171,785
$510,625
2001
$500,000
$224,400
$873,400
Restricted Stock Analysis:
Vesting Schedule
Most restricted stock has restrictions that lapse over 3-5 years.
60
55
50
40
Number of
30
CEOs
25
26
17
20
10
5
6
3
4
1
0
2
4
3
0
1
4
7
Number of Years
10
Indeterminate
Restricted Stock Analysis:
Performance Metrics


Performance-Accelerated Vesting
Schwab

These shares will vest earlier, either three or four years after the grant date in 2006

or 2007, respectively, only if certain performance criteria are met.
Guidant

The grants further provided that vesting would accelerate to three years from the

date of grant if targets for Guidant’s share price performance were achieved.
Performance-Contingent Vesting
PG&E

25% of each year’s increment is subject to forfeiture if PG&E fails to be in the top

quartile of the comparator group as measured by total shareholder return.
25% is subject to forfeiture if PG&E fails to be in the top half of the comparator

group.
Robert Half

These grants vest at a rate of 25% per year over the first four years after the grant

and are also subject to a performance condition.
Restricted Stock Analysis:
Summary Of Findings




LTI mix shifting away from options for CEOs

Value of options as percentage of Total Direct Compensation (TDC) dropped from 66% to 51%
in 2003 for S&P 500 CEOs.

Value of option grants as percentage of TDC dropped from 54% to 42% in 2003 for
Small-/Mid-Cap CEOs.
Significant increase in prevalence of restricted stock in 2003

37% of S&P 500 Executives received a stock grant in 2003, up from 32% in 2002.
Latest Equilar S&P 500 study showed over 40% of companies had awarded
restricted stock in most recent fiscal year

27% of Small-/Mid-Cap Executives received a stock grant in 2003, up from 22% in 2002.
Size of individual awards rose in 2003

S&P 500 cohort saw a 31.8% increase in median value of grant.

Small-/Mid-Cap executives saw their median stock grant increase by 28.5%.

Distribution analysis indicates that size of awards continues to migrate towards larger awards.
Overwhelming majority of stock awards continue to have time-based vesting.
Long-Term Incentive Plans
Trends

Long-Term incentive plans (LTIP) are becoming more prevalent
(over 30% in 2003).

Improved company performance led to increased payouts.

S&P500 CEOs: Median payout rose 48.6% to $1,709,391.

Small Cap CEOs: Median payout rose 43.3% to $301,490.
Design

Typically have threshold, target, and maximum performance levels.

Use 1-3 performance criteria per grant (internal/external focus).

Payout can be in stock (performance shares) or cash (performance units):
50% cash, 40% stock, 10% units

Companies often use overlapping plans so that each year starts a new
three-year cycle.
Long-Term Incentive Plans:
Number Of Metrics In Plan
# of Companies
80
70
71
60
50
40
35
30
20
9
10
6
9
0
1
2
3
# of Metrics Used
4
None
Long-Term Incentive Plans
Award Metrics
2003 LTIP Award Metrics
60
55
48
50
# of Mentions
43
40
30
20
12
10
12
14
8
7
2
0
TSR
EPS
ROA/ROE EBITDA Revenue Operating
Income
EVA
Other
Not
disclosed
Stock Ownership Guidelines


Approximately half of S&P 500 disclosed
these in compensation committee reports:
Cigna: We expect CIGNA executives to demonstrate
confidence in the company’s future by sustained ownership of
a substantial amount of CIGNA stock. In particular, we expect
the executive officers to own stock valued at between three
and five times their base salaries. The Committee reviews
ownership levels annually.
Mandatory Holding After Exercise


Must keep net shares after
exercise: Less than 10% of S&P.
Toll Brothers Inc: The options have significant restrictions,
typically for a period of three years from the date of grant, on
the executive officer's ability to exercise the options and sell
the shares acquired upon exercise……..
Combination Of Ownership
Guidelines And Mandatory Retention
CDI Corp
To further achieve the objective of aligning the interests of the company’s
executives with those of its shareholders, the Committee in 2002
established minimum CDI stock ownership and stock holding
requirements for executives. Minimum stock ownership levels range
from four times base salary for the CEO to one times base salary for
the CAO (with the other Named Executive Officers at two times base
salary). These minimum ownership levels are being phased in over a
five-year period that began in 2003. Until the minimum levels are
achieved, executives are required to retain 75% of the shares of CDI
stock they obtain from option exercises, restricted stock and other
sources. Additional measures will be imposed in the event an executive
fails to attain the minimum ownership requirements.
Flexible Choices

Sovereign Bancorp Inc
New Long-Term compensation determination policy
On February 18, 2004, the Compensation Committee
recommended to the Board of Directors and the Board of
Directors approved the implementation of a new “leading edge”
customized approach to Sovereign’s long-term incentive
compensation policy. This new long-term incentive approach is
designed to provide team members throughout Sovereign with
maximum flexibility and more meaningful long-term incentive
compensation opportunities. Team members throughout
Sovereign will be eligible to receive a combination of either
stock options, restricted stock or a cash bonus only after the
five-year incentive vesting period has elapsed from an award
date.
Restricted Stock Grant v.
Stock Options
•
•
•
•
•
•
•
Often has been part of senior executives’ comp. with options.
Popularity with institutional investors runs in cycles:
“Pay for pulse.”
Historically most useful in employee recruitment/retention when
leaving behind valuable options or when stock price flat.
Big increase expected with option expensing at levels below senior
management, although not as broadly granted as options.
Accounting treatment becomes similar between types of equity
compensation: “level playing field.”
Less dilution than with options because fewer granted.
Value in down and volatile markets: never underwater, gets
dividends, but less upside compared with options.
Local Company Disclosures

Jones Apparel Group Inc.
Performance contingent restricted shares have advantages over
stock option grants. The awards utilize substantially fewer
shares, reducing potential dilution. The awards give the
executives an immediate economic interest in Jones that will
vary up and down with stock price performance. In addition to
reinforcing the link between executive compensation and the
performance of Jones' stock, the awards also require that
minimum financial targets are achieved, adding to the incentive
value. The vesting period of the replacement awards extends
into 2006, approximately one year longer than the vesting that
applied to the original option grants, increasing retention.
Finally, the awards are cost effective, particularly since Jones
has elected to expense stock options beginning in 2003.
Bill Gates on the Move From Options to
Restricted Stock at Microsoft
•
•
•
“When you win [with options], you win the lottery. And
when you don't win, you still want it. The fact is that the
variation in the value of an option is just too great.”
“I can imagine an employee going home at night and
considering two wildly different possibilities with his
compensation program. Either he can buy six summer
homes or no summer homes. Either he can send his kids to
college 50 times, or no times.”
“The variation is huge; much greater than most employees
have an appetite for. And so as soon as they saw that
options could go both ways, we proposed an economic
equivalent. So what we do now is give shares, not options.”
What’s the Restriction?

Confused with restricted securities, performance shares, or
outright grants. Better term is “unvested stock grants.”

Restricted because you cannot sell stock until it has vested.

Vested: when sale restrictions lapse.

Lapse: no longer subject to “substantial risk of forfeiture.”

Not the early-exercise, pre-IPO options.
Vesting: Key Concept



No money paid to company (no exercise) . Not exercising to
own stock, as with options (unless pre-IPO early-exercise
options/paying money).
Unfettered ownership at vesting like any stock you own.
Time-based most popular. Not eligible for performance-based
exception under rules that limit deduction for compensation
over $1 million [ Section 162(m) ].

Performance targets: can trigger or accelerate vesting, and
performance goal must be related to company.

Termination: forfeit unvested shares.
Grant Size Trade Offs
Full value of shares at vest (not spread since grant), so fewer shares
granted compared to options. The volatility of your company's stock and
any dividend affect the value of options compared with restricted stock.
Observations by consultants about the tradeoff ratios :
Type of company
Ratio
High volatility / no dividends
(e.g., technology)
1 restricted share for 3 or
4 option shares
Moderate volatility /
moderate dividend yield
1 restricted share for 4 or
5 option shares
Low volatility / high dividend
yield
1 restricted share for 6 or
7 option shares
Tax Treatment Different from That of
Options: Two Alternatives
Standard: Pay Tax At Vesting

Taxed as ordinary income at vesting when
forfeiture risk removed (with options not taxed at vest).

Taxable income is the value of the stock when
each slice vests. Stock price at grant does not matter
unless second tax treatment alternative.

If you sell the stock, you have capital gains or losses as
with the sale of any shares.

Tax basis is the amount you included in income as
compensation.

Capital gains holding period begins at the time of
vesting.
Example: Let Shares Vest
4,000 shares of restricted stock that vest at a rate of 25% a
year; grant market price at $18.





year one: $20 (1,000 x $20 = $20,000 of ordinary income)
year two: $25 ($25,000)
year three: $30 ($30,000)
year four: $33 ($33,000)
total: $108,000
 Each increment is taxable on its vesting date.
 Sell all the stock two years after the last shares vest,
when the price is $50 ($200,000 for the 4,000 shares).
 Capital gain is $92,000 ($200,000 minus $108,000).
Second Tax Treatment:
83(b) Elections







Make a Section 83(b) election with the IRS within 30
days of the grant.
No special tax form for a Section 83(b) election.
You send the local IRS office your election with
information that identifies you and the property you
include in your income. Still attach a copy of the
election when you file your return.
Pay taxes on the value of all the stock at grant.
Remember: you cannot sell any shares until they vest.
Almost impossible to rescind election.
Advantage: tax for compensation income will
(hopefully) be lower and start capital gains
holding period.
Example with 83(b) Election
Same facts of the previous example for appreciating stock:
You make a timely 83(b) election at grant:



Compensation income of $72,000 (4,000 x $18).
Capital gain of $128,000 at sale
($200,000 minus $72,000).
Election allowed you to convert $36,000 of ordinary
income to the lower-taxed capital gains ($128,000 =
$92,000 of capital gain in the prior example plus
$36,000 that was ordinary income without the
83(b) election).
Risk with Election




You left the company: restricted stock never vested.
You cannot rescind your election or recover
the taxes you paid.
Stock price dropped by vesting: you cannot recover
taxes paid with 83(b) election.
You might be better off with using the tax dollars to buy
stock on open market. Need to run the numbers with
your advisor.
Restricted Stock Accounting




Earnings charge fixed according to grant date value
spread out over vesting/restriction lapse dates,
unless 83(b) election made.
Timing for tax deduction and earnings charge match
taxable compensation to employee when yearly vesting.
Big difference for the accounting until option expensing
is mandatory.
Need to make estimates on forfeitures (e.g., shares that
never vest). Bigger issue for cliff vesting (e.g., shares
all vest after 3 years).
Accounting Example
4,000 shares of restricted stock vest at 25% a year (1,000
shares yearly); grant market price at $18 and no 83(b) election.

year one: stock price $20 (1,000 x $18 = $18,000 earning charge
and $20,000 tax deduction)

year two: $25 ($18,000 charge, $25,000 deduction)

year three: $30 ($18,000 charge, $30,000 deduction)

year four: $33 ($18,000 charge, $33,000 deduction)

83(b) election to be taxed at grant: $72,000 earnings charge and tax
deduction
Withholding Taxes on Restricted Stock

Subject to tax withholding at vesting or 83(b) filing.

Compensation income similar to NQSO treatment on spread
at exercise. Familiar W-2 reporting.

Amount is withheld from salary, cash payment made, or
company may allow (or require) share withholding.


Company needs to have the cash to use automatic share
withholding/surrender, as no shares sold to generate funds
need to pay IRS
With share withholding/surrender, employees may have
additional reporting for securities sale on Schedule D of tax
return (company has 1099-B obligation?).
Withholding Taxes on Restricted Stock




Clear dates where actions and transactions will be occurring.
Company needs to make decisions on: communications about
83(b) election at grant; withholding/lapse election process at
vesting; timing for notifications on choices for withholding;
what to do if no election made; elections on what to do with
stock and cash
Senior executives and directors Form 4 filing if share
withholding at vesting even though no shares are “sold” into
market. Normally file form 4 with grant and then with stock
sale, not at vesting.
Companies considering Rule 10b5-1 trading plans to cover
share withholding.
ALERT: Companies can no longer lend senior executives or
directors the necessary funds for tax withholding or for
buying restricted stock.
Dividends on Restricted Stock



Dividends on unvested shares are
compensation income reported on W-2. They
are not “qualified dividends,” which are taxed
at lower rates until vested.
Dividends on 83(b) election are reported on
1099-DIV.
Approximately 10% pay dividends in more
shares, although not received until underlying
shares vest.
Restricted Stock Units:
Used by Amazon and Microsoft




Stock itself is not issued or outstanding until
the actual release of the shares at vesting.
Holders of RSUs have no voting rights.
Dividends not required as RSUholders are not
shareholders. May be dividend equivalents
based on the plan details.
Microsoft does not pay dividends on RSUs.
Made adjustments with large dividend
payment.
Restricted Stock Units:
Used by Amazon and Microsoft




Share delivery occurs at vesting in broad-based plans,
with share withholding for the taxes.
Specialized RSU plans have a deferral feature that lets
you select a date for share delivery, or one is specified
by the company (e.g., retirement).
Until American Jobs Creation Act, no income tax until
receipt of shares when election made six months or
more in advance. Now need to follow ongoing AJCA
guidance on elections.
Social Security and Medicare at vesting with deferrals.
Why Use RSUs Instead of
Restricted Stock For Grants?





Eliminates 83(b) election. No administrative burdens for
company and employee risks.
Can avoid paying cash dividends during the vesting
period.
Avoids tax at grant in countries where tax not delayed
until vesting.
RSUs do not avoid the administrative issues for
withholding taxes at vesting.
Specialized RSU plans defer delivery of the shares (not
at vesting) until date specified by executives or
termination of employment. Need to follow AJCA
guidance from IRS/Treasury.
Local Companies Using RSUs

Aramark Corp.
Restricted stock units also are granted to officers and key
employees of the Company under the 2001 Equity Incentive
Plan. Those grants are evidenced by the execution and
delivery of an RSU Agreement and vest in four equal annual
installments.
Additional Restricted Stock Units are awarded through the
Management Stock Purchase Program (MSPP). This plan
provides officers and other key employees the opportunity to
defer up to 50% of their annual bonus (25% in the case of Mr.
Neubauer) and receive instead Restricted Stock Units (RSUs).
The Company then awards additional RSUs with a face
amount equal to the amount of bonus deferred. These
matching RSUs vest in four equal annual installments
Local Companies Using RSUs
Pep Boys Manny Moe & Jack: New use of Restricted Stock Units
Beginning in fiscal 2004, we decided to replace 75% of the estimated
value of new grants of stock options with restricted stock units, or
RSUs, on a basis intended to provide comparable value to the
executive at a comparable cost to us. RSUs will result in less dilution
because, in the future, we will grant fewer RSUs than the number of
stock options that they replace because, when granted, RSUs have
more value than stock options. The grant of RSUs (a direct ownership
vehicle) will also assist officers achieve newly-implemented Pep Boys
stock ownership levels.
RSUs will vest in 20% installments over four years beginning on the date
of grant. While stock options issued in the future will continue to
become exercisable in 20% installments over four years beginning on
the date of grant, in order to further reduce potential dilution, their
term has been reduced from ten years to seven. Finally, to ensure a
more direct connection to an executive’s performance, the amount of
future equity grants will be linked to such executive’s short-term
bonus payout.
Restricted stock
calculators and
tracker
More Content on
Topic: Articles &
FAQs