SOCIETY OF ACTUARIES
Executive Compensation Plans:
United States and Canadian
Perspectives
Compensation Theory and U.S. Practice
October 4, 2001
Daniel J. Ryterband
Managing Director
Frederic W. Cook & Co., Inc.
COMPENSATION THEORY -- “SIMPLIFIED”
• Characteristics of large, industrialized
companies
– Owners are generally absentee
– Board of directors represents owners
interests
– Management is hired by the Board
– Compensation is used as a tool to incent
specific behavior
2
COMPENSATION THEORY -- “SIMPLIFIED”
(cont’d.)
• Role of compensation -- unite human capital
with financial capital to create value
– Owners provide financial capital, but not
necessarily management skills
– Employees provide management skill, but
not necessarily financial capital
3
COMPENSATION THEORY -- “SIMPLIFIED”
(cont’d.)
• Compensation objectives
– Attract
– Retain
– Motivate
All compensation elements
support these objectives,
although to different degrees
4
COMPENSATION THEORY -- “SIMPLIFIED”
(cont’d.)
Element
Rationale
Salary
 Provide for basic living expenses
 Entitlement for meeting minimum performance standards
Annual Bonus
 Focus attention on short-term strategic and financial
objectives
 Vary reward commensurate with ability to pay and shortterm performance
Long-Term Incentives
 Focus attention on multi-year strategic and financial
objectives
 Vary reward commensurate with shareholder value
creation
 Create commonality of interests between owners and
employees
 Discourage excessive short-term risk taking
Benefits
 Protect against unexpected financial hardship
 Enable employees to gracefully leave workforce
 Capitalize on cost-efficiencies provided through tax
incentives/volume discounts
5
COMPENSATION THEORY -DEVELOPMENT OF A STRATEGY
1. What is an appropriate level of compensation?
- Market pressures
- Experience and skillset
- Size and scope of job
- Criticality of position
2. How should total compensation be allocated among various elements?
- Riskiness; pay/performance relationship
- Dependence on stock price
3. What performance measures are most appropriate?
- Financial (e.g., EPS, TSR, cash flow, revenue growth)
- Strategic (e.g., market penetration, customer service, safety)
4. How should performance be measured?
- Absolute vs. relative
- Internal vs. external
Bottom Line: Ensure compensation program supports fundamental
objective of maximizing shareholder value
6
BASE COMPENSATION
(1)
Position
CEO
COO
CFO
Top HR
(2)
Group VP
(3)
Group VP
Median Compensation Rates
2000
1990
% Change
$1,175,000
743,000
465,000
375,000
513,000
412,000
$800,000
530,000
350,000
237,500
383,400
305,000
46.9%
40.2%
32.9%
57.9%
33.8%
35.1%
CAGR
3.92%
3.44%
2.88%
4.67%
2.95%
3.05%
_______________
(1)
Source: 2000 and 1990 Group 25 Compensation Survey (39 organizations, median 2000
revenue of $20.4 billion)
(2)
Over $4 Billion revenue in 2000, $2 Billion in 1990
(3)
Under $4 Billion revenue in 2000, $2 Billion in 1990
7
BASE COMPENSATION
(cont’d.)
• Observations
1. Executive salary growth rates have trailed
levels implied by media
2. Government interaction has not
prevented growth in salaries
3. Growth rates generally reflect change in
perceived importance of position
8
ANNUAL INCENTIVE DESIGN
• All successful bonus plans share common
characteristics:
1. Performance metrics are tied to critical
success factors
2. Metrics are controllable by participants
3. There is careful calibration between targets
and payout levels
–
Reasonably achievable goals
–
Perceived as fair by participants
9
ANNUAL INCENTIVE DESIGN
(cont’d.)
• Two basic design approaches:
1. Target goal setting -- awards determined
based on achievement of predetermined
goals
–
May or may not be budget-based
–
May include both financial and non-financial
goals
2. Formulaic approach -- pool of awards
determined based on a prescribed formula
relating to financial results
10
ANNUAL INCENTIVE DESIGN
(cont’d.)
Examples
Target Goal Setting Plan
Performance
Percent Target
vs. Target
Award Earned
120% or more
110%
100%
80%
Less than 80%
200%
150%
100%
50%
0%
Formula Plan
Pool equal to X% of
net income above a
Y% return on
invested capital
11
ANNUAL INCENTIVE DESIGN
(cont’d.)
Factors to consider in selecting basic approach
1. Need to focus on specific, defined goals
2. Cyclicality of the business environment
3. Difficulty of setting specific targets at corporate
and business unit levels
4. Integrity of the budget-setting process
5. Degree to which cost should be headcount
driven
6. Degree to which company wants to “manage”
size of payout
12
ANNUAL INCENTIVE DESIGN
(cont’d.)
(1)
Position
CEO
COO
CFO
Top HR
(3)
Group VP
(4)
Group VP
Target Bonus as % Salary
th
th
25 Percentile
Median
75 Percentile
100%
75%
62%
55%
65%
55%
100%
85%
72%
65%
72%
62%
125%
100%
90%
87%
95%
71%
Implied Median
(2)
Annual Cash
$2,350,000
1,375,000
800,000
619,000
882,000
667,000
_______________
(1)
Source: Year 2000 Group 25 Compensation Survey
(2)
Based on median salary and median bonus for position
(3)
Over $4 Billion in revenue
(4)
Under $4 Billion in revenue
13
ANNUAL INCENTIVE DESIGN
(cont’d.)
• Most common performance metrics
1. Earnings per share
2. Net income
3. Return on equity
4. Revenue
• Typical salary of lowest paid participant $70,000 to $80,000
14
PRIMARY LONG-TERM INCENTIVE
APPROACHES
• Stock options - provides the right to
purchase a prescribed number of shares at a
fixed price for a specified period of time
– Value is contingent on share price
appreciation
• Restricted stock - a grant of full-value stock
in which receipt is generally contingent on
meeting a service requirement
15
PRIMARY LONG-TERM INCENTIVE
APPROACHES (cont’d.)
• Performance shares - restricted stock in
which the number of shares that vest is
contingent on meeting both a service
requirement and achievement of prescribed
performance goals
– Earn-out based on both stock price change
during cycle and shares earned
– The performance cycle is typically 3 years
– Cycles can be end-to-end or overlapping
– Performance metrics are typically financial
•
Can be absolute or relative
16
PRIMARY LONG-TERM INCENTIVE
APPROACHES (cont’d.)
• Performance units - cash bonus award
structured similarly to performance shares
Prevalence of
Various Award Types*
Stock Options
Restricted Stock
Performance Shares
Performance Units
99%
56%
32%
17%
_______________
* Based on 2000 Frederic W. Cook & Co. Top 250 Study
17
PRIMARY LONG-TERM INCENTIVE
APPROACHES (cont’d.)
Position
CEO
COO
CFO
Top HR
(3)
Group VP
(4)
Group VP
Annualized Grant Date
(1)
Present Value of Long-Term Compensation
th
th
75 Percentile
Median
25 Percentile
$5.3 million
1.9
1.1
0.5
1.1
0.7
$8.4 million
5.4
1.6
1.0
1.7
1.1
$12.8 million
7.2
3.1
2.0
2.9
1.8
Implied Median
Total Direct
(2)
Compensation
$10.75 million
6.77
2.38
1.62
2.58
1.77
_______________
(1)
Source: 2000 Group 25 Compensation Survey
(2)
Based on implied median annual cash plus median LTI
(3)
Over $4 Billion in revenue
(4)
Under $4 Billion in revenue
18
STOCK OPTIONS - TWO BASIC TYPES
• Nonqualified stock options - used by most large,
mature companies
–
Provides company with favorable tax/accounting
treatment
• Incentive stock options - used more commonly by
less mature companies
–
Common among start-ups, pre-IPO companies and
those that have not yet reached profitability
•
Provides favorable accounting treatment to Company and
favorable tax treatment to employee
» Favorable tax treatment to employee comes at expense of tax
benefit to company
19
STOCK OPTIONS - INNOVATIONS
• Performance-contingent vesting - vesting is contingent
on meeting prescribed performance goals
• Performance-accelerated vesting - award vests at a
specified date (e.g., 7 years from grant) but accelerates
if prescribed performance goals met earlier
• Premium options - exercise price is set at a premium to
fair market value at grant date
–
No gain until price appreciates by a specified level
• Indexed stock options - variable exercise price, with
adjustment (up or down) tied to an index
20
STOCK OPTIONS - INNOVATIONS
(cont’d.)
• Reload stock options - upon exercise of the
original option by paying the exercise price
in the form of already owned shares, a new
grant is made automatically
– Number of reload shares exactly equal to
number of shares tendered to pay exercise
price on original grant
– Exercise price of reload grant equal to FMV
on date original award exercised
– Term of reload equal to remaining term on
original grant
21
STOCK OPTIONS - INNOVATIONS
(cont’d.)
• Reload example:
1. Employee holds 100 options
–
–
Exercise price - $10 per share ($1,000)
Term - 10 years
2. Option is exercised at 4th anniversary of grant
–
–
Fair market value - $20
Payment of exercise price - 50 shares (50 x $20 =
$1,000)
3. Reload shares granted - 50
–
–
Exercise price - $20
Term - 6 years
22
STOCK OPTIONS - INNOVATIONS
(cont’d.)
• Reload Implications (Primary Benefits)
Employee
Company



Reduced downside risk
Dividend and voting rights
Capital gains taxation



–
No EPS dilution, assuming share price remains
stable or appreciates after reload award
triggered
Accelerated tax deduction
Lower overhang
Enhanced management ownership
23
STOCK OPTIONS - INNOVATIONS
(cont’d.)
Prevalence of Stock Option Variations*
Performance-contingent vesting
Performance-accelerated vesting
Premium options
Indexed stock options
Reload stock options
5%
14%
9%
<1%
18%
_______________
* Based on 2000 Frederic W. Cook & Co. Top 250 Study
24
ACCOUNTING FOR
EQUITY-BASED INCENTIVES
• Two primary accounting standards
1. APB Opinion 25 - intrinsic value accounting
2. FAS 123 - fair value accounting
• Companies permitted to choose between the
standards
– Virtually all companies have elected to use
Opinion 25
– FAS 123 requires footnote disclosure in
annual financial statements
25
ACCOUNTING FOR EQUITY-BASED
INCENTIVES (cont’d.)
• Fundamentals of Opinion 25
– Expense equals the intrinsic value of an
award on the measurement date
– A measurement date occurs when each of
two factors are known:
1. Number of shares the grantee is entitled to
receive
2. The price the grantee must pay for the shares
26
ACCOUNTING FOR EQUITY-BASED
INCENTIVES (cont’d.)
– Factors that postpone the measurement date
result in “variable” accounting
•
For example, variability in exercise price of an
option, variability in number of performance
shares to be earned
•
Exception for vesting based purely on continued
service
27
ACCOUNTING FOR EQUITY-BASED
INCENTIVES (cont’d.)
• General measure of expense under Opinion 25
Award Type
Expense
 Stock Option (standard vesting,
performance accelerated vesting)
Option profit at grant
 Stock Option (indexed,
performance-contingent vesting)
Option profit at measurement
date
 Restricted Stock
Value of shares at grant date
 Performance Shares
Value of shares at payout date
28
ACCOUNTING FOR EQUITY-BASED
INCENTIVES (cont’d.)
• FAS 123 compensation expense
– Fair value of award at measurement date
– Fair value determined using an option
pricing model (e.g., Black-Scholes)
– Expense generally recognized over vesting
period for employee awards
29
TAX TREATMENT - A BASIC OVERVIEW
Award
Employee
Employer
Incentive Stock Options
Assuming minimum holding requirements met
(2 years from grant and 1 year after exercise),
option gain plus subsequent appreciation
taxed as capital gain upon sale of acquired
stock and no FICA/FUTA tax due. Option
profit possibly taxable under AMT
No deduction unless disqualifying
disposition occurs
Nonqualified Stock
Options
Option profit taxable as ordinary income upon
exercise; FICA and FUTA apply
Deduction equal to amount of
ordinary income recognized by
employee*
Restricted Stock
Value of shares at vesting taxable as ordinary
income, unless Section 83(b) election made
(ordinary income at grant, capital gain at sale);
FICA and FUTA apply
Deduction equal to amount of
ordinary income recognized by
employee*
Performance
Shares/Units
Value of award at vesting taxable as ordinary
income; FICA and FUTA apply
Deduction equal to amount of
ordinary income recognized by
employee*
____________
Assuming amounts deductible under Sections 162(m) of Internal Revenue Code
*
30
TAX TREATMENT - A BASIC OVERVIEW
(cont’d.)
• Section 162(m)
– Limits the allowable deduction for proxy
named executives to $1 million per year per
executive
– Exception for “performance-based”
compensation:
•
Granted pursuant to a plan in which material
terms are shareholder-approved
•
Size of the award must fall within an individual
limit specified in the plan
•
Plan must be administered by a committee
composed solely of 2 or more outside directors
31
PROXY STATEMENT DISCLOSURE RULES
• The SEC requires publicly-traded U.S.
companies to disclose compensation paid
for the prior fiscal year
– CEO and each of the 2nd through 5th highest
paid executives
•
Named executive officers, or NEOs
• There are 3 inter-related components:
1. Narrative description of policies, philosophy,
and issues that influence compensation
decisions
32
PROXY STATEMENT DISCLOSURE RULES
(cont’d.)
2. Overview of pay amounts in the “Summary
Compensation Table” for NEOs
3. All other tables and descriptions
• Summary Compensation Table:
–
Salary and bonus paid, including deferred amounts
–
Other annual compensation, including perquisites
(in excess of $50,000 or 10% of base and bonus),
dividends on LTIP awards (excluding R.S.), “abovemarket” deferred interest, tax reimbursement or
gross-up payments, and discounts on purchases
of company stock
33
PROXY STATEMENT DISCLOSURE RULES
(cont’d.)
– Grant value of restricted stock
– Number of option shares or stock
appreciation rights
– Value of LTIP awards earned
– Value of “All Other Compensation,” including
split-dollar life insurance and allocations
under DC retirement plans
34
PROXY STATEMENT DISCLOSURE RULES
(cont’d.)
• Other tables/descriptions include:
– Option/SAR grant table - lists options or SARs
granted, exercise price, expiration date,
hypothetical “value”
•
Value estimated based on either Black-Scholes
Model or projection over term at 5% and 10%
appreciation rates
– Option exercise table - lists shares covered by
exercises, gain at exercise date, number of
exercisable and unexercisable outstanding
options, intrinsic value of exercisable and
unexercisable outstanding options
35
PROXY STATEMENT DISCLOSURE RULES
(cont’d.)
– LTIP table - lists shares granted, performance
period, and estimated future payouts at
threshold, target, and maximum earn-out
– Other - stock performance graph, pension
table, summary of employment agreements,
description of director pay, beneficial
ownership table, repricing table
36
COMPENSATION TRENDS
• The Drivers
– Revolution in communication and medical
technology
– Emergence of the “New Economy”
•
Increased productivity
•
High growth with low inflation
•
Abundant capital
•
Favorable stock market conditions
– Economic slowdown and Nasdaq
“correction”
37
COMPENSATION TRENDS
(cont’d.)
• The Results
– Leaner organizations with higher
performance-based pay
– Shareholder-value strategic focus
– Explosion in equity-pay component
•
Many different forms
•
Bigger values and more participants
•
Higher share usage and dilution
– Increased shareholder scrutiny
38
HOT TOPICS
1. Stock Option Dilution
2. Underwater Options
3. Use of Non-Shareholder Approved Equity
Plans
4. Pay for Performance Linkage
5. Stock Ownership
6. Continuing Accounting Debate
39
STOCK OPTION DILUTION
• Ways to measure dilution
1. Run rate
– Annual options granted as a percent of
outstanding
2. Overhang (diluted basis)
– Potential share dilution attributable to outstanding
options
A , where A equals outstanding options and B
A + B equals outstanding shares
--
Example: 100 outstanding shares and 10
options equals 9.1% {10/(10 + 100)}
40
STOCK OPTION DILUTION
(cont’d.)
3. EPS dilution
– Difference between diluted and basic EPS
– Diluted shares outstanding include equivalent
shares attributable to options
•
“Net shares added” calculated under Treasury
stock method
»
Assumes all outstanding options are
exercised and proceeds are used by
company to repurchase portion of shares
issued
»
Proceeds equal to exercise price plus tax
benefit
41
STOCK OPTION DILUTION
(cont’d.)
• Financial impact of dilution on shareholders
– Reflected in diluted EPS, which translates
into lower share price
– Stock price = diluted EPS x P/E ratio
• Additional options create incremental EPS
dilution
• Investor concerns
– Focus is primarily on overhang, rather than
EPS dilution
42
STOCK OPTION DILUTION
(cont’d.)
– Short-sighted for several reasons
1.
Treats underwater options similar to in-themoney awards
2.
Doesn’t address EPS implications
3.
Doesn’t address “cost” of options already
exercised
• General rules of Thumb
– Typical run rate - 2% for old economy, 4% for
new economy companies
– Tolerable overhang - 10% for “old
economy”, 20% or more for “new economy”
43
STOCK OPTION DILUTION
(cont’d)
• Growth in run rate and overhang has been
substantial
Median Levels*
1999
1989
Run Rate
2.07%
1.05%
Overhang**
13.07%
6.90%
* Source: Pearl Meyer & Partners “1999 Equity Stake”
** Includes awards outstanding plus shares reserved for future
grant
44
STOCK OPTION DILUTION
(cont’d.)
• Investor reaction
– Average negative votes by shareholders on
share reserve requests in 2000 was 20.7%
• Up from 17.4 in 1997
– The greater the size of the request, the
greater the negative vote
Proposal as %
Shares Outstanding
Less than 5%
5% - 9.9%
10% or more
Negative
Votes
19%
22%
31%
* Source: Investor Responsibility Research Center
45
UNDERWATER OPTIONS
• 1990’s bull market ended in March 2000
High
Nasdaq
S&P 500
DJIA
5,049
1,527
11,723 8,727
Current
(10/19/01)
Percent Change
1,528
-70%
1,015
-34%
-26%
• Underwater options complications
– Reduces retention/performance incentive
– Encourages overly risky behavior
– Fosters build-up of excessive overhang
46
UNDERWATER OPTIONS
(cont’d.)
• Traditional Solution - “reprice”
–
Cancel and reissue, or reset exercise price
–
New accounting rules result in variable
expense for “repriced” options
• Alternatives for dealing with underwater
options
1.
Do nothing - stay the course; long-term
focus
47
UNDERWATER OPTIONS
(cont’d.)
2. Accelerate next year’s grant
–
Takes advantage of depressed price
–
May backfire if share price falls further
3. Extra, on-top grant
–
Takes advantage of depressed price
–
Increases overhang (can use short term to
minimize) and EPS dilution
4. Selective restrictive share grants
–
Restores retention/incentive value
–
Creates P&L charge
48
UNDERWATER OPTIONS
(cont’d.)
5. Collared options
–
New grants made, which vest and expire
6 months and a day after price target reached
–
Increases overhang and EPS dilution
–
Protects against “double dip” after price recovers
6. Buy-out underwater options for restricted stock
–
Reduces overhang substantially
–
Restores retention/incentive value
–
Creates P&L charge
–
Must be timed to avoid “repricing”
• 6 months and 1 day rule
49
UNDERWATER OPTIONS
(cont’d)
7. Cancel now, regrant later
–
Employees surrender options now in exchange
for promise to grant new awards later
–
Reduces overhang if exchange ratio based on
economic equivalency
–
Creates perverse incentive during waiting period
–
Must be timed to avoid “repricing”
• 6 months and 1 day rule
50
USE OF NON-SHAREHOLDER
APPROVED EQUITY PLANS
• Why get shareholder approval?
– Tax deductibility under Section 162(m)
– State law requirements
– Exchange/market-based rules
– Statutory requirements - ISOs, Section 423
plans
– Corporate governance
51
USE OF NON-SHAREHOLDER
APPROVED EQUITY PLANS (cont’d.)
• Exchange-based rules - Nasdaq and New
York Stock Exchange
– Generally require shareholder approval of
plans/arrangements in which
officers/directors may acquire stock
– Exceptions include:
• “Broadly based” plans
• New hire awards
• Grants made from treasury stock (NYSE only)
• Other limited arrangements
52
USE OF NON-SHAREHOLDER
APPROVED EQUITY PLANS (cont’d.)
• What is “broadly based”
– Nasdaq - no specific definition
– New York Stock Exchange
1. Majority of full-time, exempt U.S. staff eligible
2. Majority of awards to non-officers/directors
•
Use of broadly-based plans has increased as a
result of:
–
–
Difficulty in receiving shareholder approval for
increased share authorization
Increased lower level employee participation
53
USE OF NON-SHAREHOLDER
APPROVED EQUITY PLANS (cont’d.)
• Response:
– Intense criticism from institutional investors
and shareholder activists
– Arthur Levitt threatened exchanges with
SEC regulation before retiring
– NYSE proposed new rules to replace
existing shareholder approval requirements
• Adoption conditioned on Nasdaq agreement to
adopt identical standard
– Nasdaq under pressure from listed
companies to resist
– Future is uncertain
54
PAY FOR PERFORMANCE LINKAGE
• Media and other critics focus on:
– Extraordinary events/specific companies
– Option gains, which may represent years of
stock price appreciation
– Payment for failure (e.g., severance)
• Not truly compensation
• More like an insurance policy for executives
55
PAY FOR PERFORMANCE LINKAGE
(cont’d.)
• Tolerance/patience for underperformance is
extremely limited
– CEO job security has never been lower
– Market reaction to short-term earnings
shortfall is extreme
• Recessionary conditions testing the pay-forperformance standard in 2001
– Many companies have already announced
no bonus
• Emphasis on stock options directly ties CEO
compensation to shareholder value creation
56
PAY FOR PERFORMANCE LINKAGE
(cont’d.)
CEO Pay versus Company Performance An Alternative Method of Valuing Stock Options
($ Millions)
Name
Company
Salary
Plus
Bonus
Long-Term
Incentives
Excluding
Options
Stock Option Value
Business
F.W.
Week Cook Gain on
Change
Exercised
in Option
(1)
Value
Options
Total
Compensation
Business
F.W.
Week
Cook
Total
Shareholder
Return
over Same
Period
John Reed
Citigroup
$5.4
$0.0
$287.6
$26.9
$293.0
$32.3
23.5%
Sanford Weill
Citigroup
19.9
8.7
196.2
162.9
224.9
191.5
23.5%
Gerald Levin
AOL Time Warner
11.2
0.0
152.6
(80.3)
163.8
(69.1)
-4.2%
John Chambers
Cisco Systems
1.3
0.0
156.0
799.5
157.3
800.9
110.7%
Henry Silverman
Cendant
7.6
0.0
129.1
(515.1)
136.7
(507.5)
-63.8%
L. Dennis Kozlowski
Tyco International
4.2
21.2
99.9
49.1
125.3
74.4
0.6%
Jack Welch
General Electric
16.8
48.7
57.1
(37.7)
122.6
27.7
-6.0%
David Peterschmidt
Inktomi
0.7
0.0
106.9
187.9
107.6
188.7
90.0%
Kevin Kalkhoven
JDS Uniphase
0.7
0.0
106.2
1,185.9
106.9
1,186.7
477.7%
David Wetherell
CMGI
1.2
0.0
102.5
(45.5)
103.7
(44.3)
-17.8%
(1)
Change in Option Value = Value of unexercised options at end of year plus Value of gains realized from options exercised during
the year minus Value of unexercised options at the start of the year
57
STOCK OWNERSHIP
• Market forces strongly encourage high levels
of company ownership among senior
executives
– Stock sales by leadership team are viewed as
a “sell signal” by investors
– “Flipping” of stock is difficult to justify when
executives are receiving “mega” option grants
• Among major U.S. companies, about 65%
impose stock ownership requirements
58
STOCK OWNERSHIP
(cont’d.)
• Guidelines are typically expressed as a
multiple of salary
Median Guidelines
Position
CEO
COO
EVP
SVP
VP
Multiple of Salary
5.0X
3.0X
3.0X
2.0X
1.5X
* Source: F.W. Cook survey of 195 companies as of 8/1/01
–
–
A minority of companies use a fixed number of
shares
Retention ratio approach becoming more common 59
STOCK OWNERSHIP
(cont’d)
• Guidelines have limitations
– Achievement of target suggests permission
to sell
– Pursuit of target creates pressure for
special grants/programs
– Failure to achieve target creates little
consequence
60
STOCK OWNERSHIP
(cont’d.)
• What is the right level of ownership?
– Academic studies have attempted to
address issue
– Too much ownership makes management
risk aware
– Too little ownership promotes conflict with
shareholder interests
• Result: inconclusive
61
CONTINUING ACCOUNTING DEBATE
• Two primary issues
1. Interpretation of APB Opinion 25
2. Global accounting standard for stock
options
• Interpretation of APB Opinion 25
– Financial Interpretation Number 44 released
by FASB on 3/31/00, followed by EITF 00-23
62
CONTINUING ACCOUNTING DEBATE
(cont’d.)
• Major implications (generally):
1. Opinion 25 applies only to employees and
nonemployee Board members and only to
stock compensation based on grantor
company shares
•
All other grants accounted for under FAS 123
as of vesting date
2. Repriced options subject to variable
expense until exercised or forfeited
63
CONTINUING ACCOUNTING DEBATE
(cont’d.)
3. Share withholding in excess of minimum
statutory rates results in variable
accounting
4. Modifications to a vesting schedule result in
a new measurement date
5. Direct or indirect extension of an option’s
term results in a new measurement date
6. Company “call” rights and employee “put”
rights permissible if repurchase occurs 6
months or more after option exercise
64
CONTINUING ACCOUNTING DEBATE
(cont’d.)
7. Adding a reload feature results in variable
accounting
8. Exhaustive list of additional complexity
associated with special circumstances
9. Interpretation is ongoing . . .
•
Reload stock options now under attack
• Global stock option accounting standard
– IASB currently reviewing development of a
global standard
65
CONTINUING ACCOUNTING DEBATE
(cont’d.)
– Likely direction is toward “fair value”
approach
•
Black-Scholes value measured as of grant date
(or vest date) and recognized over vesting
period
– Any proposal will be met with significant
criticism
66