To mitigate the pressure that this will put on share usage, the company can apply a discount to the LTI target award value that partially adjusts for the impact of the stock price decline. Reduces value of long-term incentive award to all employees Approach 6.
A Compelling Alternative to Stock Options
Depending on the Black-Scholes value of stock options, the ratio of options to full value shares may be as low as 2: For companies with equity plans that are not based on a fungible pool that treat options and full value shares the same, shifting the long-term incentive mix away from stock options towards full value shares can help ensure that equity grants will not exhaust the available pool. Maintains target long-term incentive award value, potentially avoids exhausting share reserve, simple; equitable treatment across employees Disadvantages: Use long-term cash instead of full value equity awards Companies can conserve shares and reduce burn rate by replacing equity awards with cash.
The most common approach is to grant long-term cash incentive awards instead of performance shares. Both types of award can be constructed with similar time frames, identical metrics and identical target values. But there are two significant differences. First, the ultimate value of performance shares will leverage up or down over the performance period in line with the value of the underlying shares. This exposes compensation realized by participants to additional volatility during periods when stock prices are uncertain.
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Cash awards will have more certainty and may therefore be valued more highly. Second, long-term xlternative awards are almost always settled in cash. Therefore, ancillary considerations, such as stock ownership guidelines, post-vesting holding periods, blackouts and insider trading policies are off the table. In addition, long-term cash awards are not factored into burn rate calculations or into the estimates shareholders apply to the cost of equity plans.
Similarly, long-term cash awards are not counted in calculations of overhang from equity plans or counted against equity compensarion share reserves, provided the awards are not denominated in share units settled in cash. For example, some plans use relatively long vesting schedules e. Alternatively, it would be possible to achieve compensaton goals of retention and performance incentives by granting a target number of phantom shares and then adjusting the number of shares upon which payment will be made based on the company's performance over a specified performance period.
Although it is a broad generalization, it would be more common to see top-level executives receiving SARs because the executives would be perceived as making policy-type decisions more likely to affect the stock pricenext-tier executives receiving a combination of SARs and phantom stock, and still lower-level recipients receiving all phantom stock to encourage retention. From Chapter 4, "Performance Award Plans" Successful implementation and rollout of a performance equity plan may require new internal communication and data integration techniques; the communication regarding the entire life of each award must be seamless.
Unlike time-based awards that require equihy in the way of regular management, unless there is a major corporate or individual event, performance equity requires integration at the optkons of the award, at regular intervals at least quarterly during the measurement period, at the time of final measurement, and at the time of vesting and payout. Building these processes at the outset will afford focus on the effectiveness of the plan, rather than the process. Awards with market conditions require complex valuation upon grant. While the financial reporting after the award date is fixed, the progress toward the goal is not.
Implementation should include a method and frequency for determining proximity to the goal. Communication of this proximity must also be defined to ensure that the award is fulfilling its intended objectives. Awards with performance conditions can be valued in a manner similar to time-based equity. The expense for these awards must be evaluated every quarter, based on the probability of attaining the goal s associated with the award. A company must always amortize expense based on no less than the number of shares that are probable to vest.
Depending on the nature of the goal, this may be a simple formula or it may require interaction between multiple departments and data sets. Approachhes values used in the probability to vest may not always coincide with the proximity details being communicated to the staff. Attaining various pre-established share price hurdles will result in increasingly higher equity payouts like a tra-ditional performance share plan. The hurdles mimic the value creation that would be achieved with an option grant. This design helps to preserve some of the retentive value, but still provides significant leverage and potential payout to the executive if they meet operational targets and grow the share price over time.
As such, the plan essentially mirrors an option but within a specified range of prices.
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The distinction between a CPVE vehicle and options is twofold: An option exposes executives to a equuty downside risk if the stock price falls below the exercise price. Underwater options do not contain any type of natural correction mechanism to preserve their retentive value. CPVEs limit that downside as long as the operational financial goals have been metthereby preserving some of the retentive value in the grant, even in the face of poor stock price performance. We recently worked with a compensation committee to develop a CPVE plan for a company that competes within a historically volatile industry.