Benefits of issuing stock options

COMPANIES CHOOSING THE REPRICING Issuing must act carefully because of FASB Interpretation no. The new accounting rule discourages companies from making a quick leap to reprice stock options in response to a market downturn.

Repricing becomes much more painful. For employees, restricted stock consists of grants of actual shares that can be forfeited unless vested by continuous employment.

Any rise options the value of the option above its new, lower strike price must be charged against earnings. Companies may choose to redesign their compensation plans due to the wholesale losses in their stock value. In an upside-down investing world, financial managers, option holders and CPAs need to be aware of alternative stock option plan strategies.

Until last year, many companies issuing at stock options as a no-lose proposition for everyone. Statistics compiled by the National Association of Stock Plan Professionals NASPP and PricewaterhouseCoopers LLP quantify that enthusiasm. Now, particularly in the technology, telecommunications and dot. To fill the breach, companies are frantically scrambling to find remedial compensation approaches to protect employees from market losses while also addressing accounting, tax and corporate governance concerns.

These alternatives, discussed here, include repricing stock options, canceling options and reissuing them at a lower strike price after a six-month-and-one-day waiting period and substituting underperforming stock options with other payment programs, such as restricted stock.

Stock options, the most widely used form of incentive compensation, give employees the right to buy a set number of shares of company stock at a set price for a certain period. They became ubiquitous because compensating employees with stock options entails no cash expenditures. Stock the same time, the business receives favorable accounting treatment since there are no charges to earnings.

Employees also benefited when they exercised their stock options and held on to their shares. REPRICING NO LONGER ROUTINE. But new accounting rules stock companies from making a quick leap to reprice stock options in response to a market downturn.

Benefits companies choosing the repricing strategy, typically formerly high-flying technology and dot-com companies, have little or no earnings and include according to Institutional Shareholder Services ISS in Bethesda, Maryland Amazon.

These entities must act carefully because of FASB Interpretation no. Simply lowering the exercise price of existing options or perhaps canceling them benefits regranting a new set of options now forces companies to mark the value of the awards to the market price each quarter for the options life of the options.

Thus the options become variable for accounting purposes and any rise in value above the new, lower strike price must be charged against earnings. The charge is open-ended and impossible to predict. Even so, as Patrick McGurn, vice-president and director of corporate programs at ISS notes, Interpretation no.

That appears to be a startling increase over the past: Variable Accounting in Compensation Plans. Companies view stock option plans with features subject to variable accounting as at a disadvantage because, with variable accounting, compensation costs are charged to earnings.

In fixed option plans the option price and number of shares are known on the grant benefits and only the intrinsic value a discounted price needs to be expensed on financial statements. Most fixed option plans have no intrinsic value at grant date and options compensation cost is recognized for them under APB Opinion Variable plans result from issuing to stock existing option grant, or when the options are issuing based, and future appreciation must be expensed until the options become fixed.

Because repricing options is available to employees and not shareholders, the method is a governance issue; Benefits Interpretation no. Paula Todd, CPA and principal specializing in executive benefits stock-based compensation at Towers Perrin, a consulting firm in New York, says even though there were always reasons against repricing options, it still may be the best course of action for companies with sophisticated investors.

In this scenario, the company pays the employee, but less than if the options had a higher strike price. But employees are getting paid, and there is likely to be less stock dilution.

The good news issuing this technique allows companies to reprice their shares at no cost and without diluting the stake of existing shareholders.

It is also a way to avoid the potentially costly complications of repricing options subject to FASB Interpretation no. A options can happen in six months, leaving employees with a gamble and guesswork in volatile markets.

Under accounting rules, companies that cancel their options and stock six months and one day can reissue stock options at a lower price and preserve fixed accounting treatment. This is clearly the strategy options jour: In practice, slow-motion exchanges, which are treated as a tender offer in the proxies, are controversial.

Among the raft of companies using this strategy, according to ISS, are Actel, Ariba, Commerce One, E. It permitted 24, of its options to turn in their old options. Perhaps the least popular incentive compensation formula because options its tax benefits, but one that some companies stock deployed this year nonetheless, is to cancel options and replace them with issuing of restricted stock.

The chief advantage to a company of issuing restricted stock, which ISS calculated at least 8 of 75 companies used to alter their stock option plans, is that the technique acts as a retention tool because of the partial vesting feature.

At the same time, the company can expense the stock over four years and avoid variable accounting. For employees, restricted stock consists of grants of actual shares that can be forfeited unless fully vested by continuous employment for a specified term. Armstrong Holdings, Avid Technology, Infonautics, Priceline. Rather than using any of the three methods, several companies chose simply to issue more stock options benefits top of benefits options.

Cisco Systems, Lucent Technologies, Microsoft and Intel were among the seven companies cited by ISS as preferring this course. By not canceling the underwater options, companies spared themselves the trouble of doing variable accounting.

Clearly, businesses that relied on stock options are stock a fierce bind and must now struggle to retain talent. It used to be that stock options were equal to cash. When stock prices were rising relentlessly, U. Employees coveted benefits, expected and demanded them, and they became a powerful currency to attract and retain people. They also made good cocktail party talk: Moreover, stock options became an important retention tool.

Shareholders benefits also kept happy. Shareholder activists who might have fretted more about outsized salaries to top executives were quiet when they themselves were benefiting. But in recent months all U. The Nasdaq trades the bulk of those high-technology companies that are the most avid employers of stock option compensation for nonmanagerial employees. For Internet companies, the news was even worse.

The stocks of most e-commerce firms plummeted. Among myriad examples, Priceline. And a startling number have gone belly-up. Some employees at e-commerce and technology companies stock only have watched the value of their stock plunge after the options were options but also came to owe a significant amount in federal taxes calculated on stock value of the options. Stock options, like other forms of incentive compensation, are intended to motivate employees to perform better than they might without the added incentive.

The benefit is less dependence on stock, which can carry obvious disadvantages. When share prices plummet, options can wind up empty-handed. CPAs who advise on financial planning matters can help to guide their clients through incentive compensation pitfalls. Company management, employees and ultimately shareholders do not always find the option alternatives—repricing, slow-motion exchanges and issuing restricted stock—satisfactory. Although these strategies are measurably better than simply paying employees additional cash which is a problem for start-ups, for examplethey all might carry undesirable accounting, tax or public policy consequences, making them much less appealing to companies and employees than issuing stock options in a different market environment.

And long-term incentive pay stock not effective when the market slumps. Benefits managers need to find ways to reduce the effects of stock volatility in their compensation programs without costing their companies additional money. This report issuing how SMBs can properly protect private information from breaches, design and implement a cybersecurity policy, and create safeguards for training and education.

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TOPICS Management Accounting Strategy and Governance. EXECUTIVE SUMMARY AS THE STOCK Issuing SLUMPEDthe use of issuing options as the ideal form of employee compensation lost some stock its luster. To fill the breach, companies are scrambling to find remedial compensation strategies to protect their employees from market losses.

PAUL SWEENEY is a freelance writer in Brooklyn, New York. Issuing e-mail address is pswe aol. TIAA-CREF, New York City, www. Variable Accounting in Compensation Plans Companies view stock option plans with features subject to variable accounting as at a disadvantage because, with variable accounting, compensation costs are charged to earnings.

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SUBSCRIBE Get Journal of Accountancy news alerts Be the first to know when the JofA publishes breaking news about tax, financial reporting, auditing, or other topics. NEWS APP How to add the JofA to your Apple News app This quick guide walks you through the process of adding the Journal of Accountancy as a favorite news source in the Issuing app from Apple. AS THE STOCK MARKET SLUMPEDthe use of stock options as the ideal form of employee options lost some stock its luster.

Issuing Equity to Employees: Stock Options and Restricted Stock for Founders and Employees