Stock-based Compensation

October 2002 Stock-based CompensationStock-based Compensation

Stock-based CompensationStock-based

Compensation


Brad OwenBrad Owen Senior Manager, KPMG LLP

- 10 years CA - 1995; CPA (Illinois) - 1999 Specialize in US GAAP and SEC

reporting Review US GAAP reconciliations

for a number of public companies in Canada

Clients include Siemens AG, AGI, Stuart Energy

Senior Manager, KPMG LLP- 10 years

CA - 1995; CPA (Illinois) - 1999 Specialize in US GAAP and SEC

reporting Review US GAAP reconciliations

for a number of public companies in Canada

Clients include Siemens AG, AGI, Stuart Energy


Agenda

Agenda What is it?

Why do we care? Basic accounting issues Accounting models

- G+4 (IASB proposal)- FASB- CICA

Investors’ concerns

What is it? Why do we care? Basic accounting issues Accounting models

- G+4 (IASB proposal)- FASB- CICA

Investors’ concerns


What is Stock-based Compensation

What is Stock-based Compensation

Consideration in return for goods or services - Employee or non-employee- Consideration can be Options,

direct share awards or liabilities indexed to common shares

Excludes shares issued for cash (IPO’s)

Consideration in return for goods or services - Employee or non-employee- Consideration can be Options,

direct share awards or liabilities indexed to common shares

Excludes shares issued for cash (IPO’s)


Why Do We Care?

Why Do We Care? Stock-based arrangements are

front and centre in the press ∽ 90 % of TSE 100 companies

have at least one equity-based program for directors

7 of 99 provide only options as remuneration

Stock-based arrangements are front and centre in the press

∽ 90 % of TSE 100 companies have at least one equity-based program for directors

7 of 99 provide only options as remuneration


Why Do We Care?

Why Do We Care?

47% make annual option grants

Growth in option-based awards expected to continue

47% make annual option grants

Growth in option-based awards expected to continue


Value of New Options—US Data

Value of New Options—US Data

0

200

400

600

800

1000

1200

1400

1600

1800

2000

1994 1995 1996 1997 1998

Value peremployee

*Based on 144 large S&P 500 firms Source: US Federal Reserve Board


Income Statement Impact

Income Statement Impact

(1) US GAAP

Y/E Basic EPS(1)

Proforma EPS(1)

% Change

Agrium ‘01 ($0.49) ($0.51) (4.08%)Alberta Energy ‘01

5.24 5.06 (3.4%)

ATI Techn. ‘00 (0.47) (0.53) (12.77%)CN Rail ‘01 5.41 5.37 (0.74%)Celestica ’01 (.40) (0.45) (12.5%)Four Seasons ‘01

1.65 0.77 (53.33%)

Noranda ‘00 3.77 3.52 (6.63%)Nortel ’01 (8.56) (9.08) (6.07%)Rogers ‘01 (2.16) (2.31) (6.94%)Shaw ‘00 0.35 0.33 (5.71%)Computer Ass. ’02

(1.91) (2.05) (7.33%)

GE ’01 1.38 1.35 (2.17%)Microsoft ‘01 1.38 0.95 (31.16%)


Goals of Plans—R3

Goals of Plans—R3

Retention- Medium to long-term plans- 3-year performance period avoids

tax cost for recipient Rewarding performance

- Qualitative goals- Quantitative goals

Recruiting in New World economy

Retention- Medium to long-term plans- 3-year performance period avoids

tax cost for recipient Rewarding performance

- Qualitative goals- Quantitative goals

Recruiting in New World economy


Effectiveness of Plans


“Time” is not a performance enhancer

Employees typically don’t hold shares- Roth/Nortel

Drives behaviors that focus on short-term appreciation in stock price- Pump and dump (Enron allegation)

“Time” is not a performance enhancer

Employees typically don’t hold shares- Roth/Nortel

Drives behaviors that focus on short-term appreciation in stock price- Pump and dump (Enron allegation)




2001 CEO Ownershi

p ($ millions)

Ownership to

Salary

1-year TRS (1) ROE

1-year EPS

Growth

High $30.0 51.6:1 20.7% 14.9% 17.6%Low $1.8 3.4:1 0.0% 11.7% 10.7%All $7.0 11.1:1 11.0% 13.4% 14.2%

Based on stock owned at the beginning of 2001CEOs in high ownership group had a medium ownership stake of $30MCEOs in low ownership group had a medium ownership stake of $1.8M

(1) Total return to shareholders


Basic Accounting Issues

Basic Accounting Issues

How to measure it?- Initially- Subsequently

When does it get recognized, if at all?

How to present it?

How to measure it?- Initially- Subsequently

When does it get recognized, if at all?

How to present it?


Measurement Issues

Measurement Issues

Measurement amount:- Fair value- Intrinsic value- No value/historical cost

Measurement dates:- Grant date- Service period- Vesting date- Exercise date

Measurement amount:- Fair value- Intrinsic value- No value/historical cost

Measurement dates:- Grant date- Service period- Vesting date- Exercise date


Measurement Amount—Stock Options

Measurement Amount—Stock Options Fair value = IV + Time Value

- Willing buyer/willing seller- Quoted market price (QMP)- Estimation models

Intrinsic value (IV) = market price of underlying – exercise price- Can never be negative- Can be zero

Historical cost = 0

Fair value = IV + Time Value- Willing buyer/willing seller- Quoted market price (QMP)- Estimation models

Intrinsic value (IV) = market price of underlying – exercise price- Can never be negative- Can be zero

Historical cost = 0


To Measure or Not to Measure

To Measure or Not to Measure

Options have value, even when issued out of or at the money- Inability to transfer doesn’t negate value- They’re not free to employee or the entity- Have value even if not exercised

• Dot.com phenomena- Measurement difficulties

Cash paid for employee services is not ignored- Why should medium of exchange matter

Options have value, even when issued out of or at the money- Inability to transfer doesn’t negate value- They’re not free to employee or the entity- Have value even if not exercised

• Dot.com phenomena- Measurement difficulties

Cash paid for employee services is not ignored- Why should medium of exchange matter


Which Measurement Basis?

Which Measurement Basis?

Reciprocal transactions generally are measured at FV- E.g., business combinations

consummated with shares not considered a capital transaction

Intrinsic value method lead to financial engineering in US- APB 25: no compensation cost

recognized at all

Reciprocal transactions generally are measured at FV- E.g., business combinations

consummated with shares not considered a capital transaction

Intrinsic value method lead to financial engineering in US- APB 25: no compensation cost

recognized at all


Option Pricing Models


Black-Scholes Binomial Example:

- Share and exercise prices = $10- Expected life of option = $5- Expected volatility = 60%- Risk-free rate = 3%= $1.59

Black-Scholes Binomial Example:

- Share and exercise prices = $10- Expected life of option = $5- Expected volatility = 60%- Risk-free rate = 3%= $1.59


Option Pricing Model Assumptions

Option Pricing Model Assumptions Exercise price

- higherlower FV

Expected life of option- longerhigher FV

Current price (FV) of underlying stock- higherlower FV

Expected volatility- higherhigher FV

Expected dividend yield- higherlower FV

Risk-free rate during term of option- higherhigher FV

Exercise price - higherlower FV

Expected life of option- longerhigher FV

Current price (FV) of underlying stock- higherlower FV

Expected volatility- higherhigher FV

Expected dividend yield- higherlower FV

Risk-free rate during term of option- higherhigher FV


Measurement Problems—



Option Pricing Models Gaming through assumption manipulation- Reverse engineer FV

Even with the simple plans- Difficult to estimate volatility;

projected dividend yield- History not necessarily good

indicator

Gaming through assumption manipulation- Reverse engineer FV

Even with the simple plans- Difficult to estimate volatility;

projected dividend yield- History not necessarily good

indicator





Option Pricing Models Delayed vesting- Modify standard binominal model

Forfeiture provisions- Need to estimate and adjust for

probability

Delayed vesting- Modify standard binominal model

Forfeiture provisions- Need to estimate and adjust for

probability





Option Pricing Models Non-transferability- Employees value stock less than

cash- FASB focus on value to entity

Capital structure effects- Issuer to exchange traded options

not the entity

Operating income effects

Non-transferability- Employees value stock less than

cash- FASB focus on value to entity

Capital structure effects- Issuer to exchange traded options

not the entity

Operating income effects


US Reaction to Proposed FV Model

US Reaction to Proposed FV Model

Vociferous lobbying of the FASB- Negative market impact on stock prices

Focus on recognition, not disclosure- Information inefficiency???

Non-binding Senate resolution opposing FV model

Changed to FV-disclosure option (except non-employee options)- Definition of non-employee broad

Vociferous lobbying of the FASB- Negative market impact on stock prices

Focus on recognition, not disclosure- Information inefficiency???

Non-binding Senate resolution opposing FV model

Changed to FV-disclosure option (except non-employee options)- Definition of non-employee broad


Measurement Dates

Measurement Dates Grant date

Service date Vesting date Exercise date

Grant date Service date Vesting date Exercise date


Grant DateGrant Date

Date employer and employee come to mutual understanding of the terms- Can’t occur prior to start date- Can’t occur prior to shareholder approval, if

required or requested

Subsequent changes in value ignored Earliest measurement date

—”cheapest” cost if share prices rising

Date employer and employee come to mutual understanding of the terms- Can’t occur prior to start date- Can’t occur prior to shareholder approval, if

required or requested

Subsequent changes in value ignored Earliest measurement date

—”cheapest” cost if share prices rising


Service Date

Service Date

Measure as perform service:- Theoretically 365 measurement dates in

a year of service

Subsequent changes in value ignored for units already recognized

Final measure will be approx. equal average share price in the period

Measure as perform service:- Theoretically 365 measurement dates in

a year of service

Subsequent changes in value ignored for units already recognized

Final measure will be approx. equal average share price in the period


Vesting Date

Vesting Date

Date award vests Interim changes in value

considered- Variable accounting

“Expensive” relative to grant or service dates in a rising market

Date award vests Interim changes in value

considered- Variable accounting

“Expensive” relative to grant or service dates in a rising market


Exercise Date

Exercise Date

Date award is exercised May be years after service

rendered to earn award Changes in interim period

considered:- Variable accounting

Post-vesting and post-employment Most expensive date in rising

market

Date award is exercised May be years after service

rendered to earn award Changes in interim period

considered:- Variable accounting

Post-vesting and post-employment Most expensive date in rising

market


Example

Example Assume granted 750 options

Exercise price is $15 and QMP is $15 EOY QMPs: $16; $17; $18 Fair value is $3 on grant date EOY FVs: $4; $5; $6

- (not realistic to assume TV constant) Vest over 3 years Term 10 years: FV and QMP at end

of term $20 and $35, respectively

Assume granted 750 options Exercise price is $15 and QMP is $15 EOY QMPs: $16; $17; $18 Fair value is $3 on grant date EOY FVs: $4; $5; $6

- (not realistic to assume TV constant) Vest over 3 years Term 10 years: FV and QMP at end

of term $20 and $35, respectively


Compensation Cost

Compensation Cost Grant date:

- $2,250= $3*750 options if FV used- Nil if intrinsic value is used

Service date:- $3,750 if FV used

• ($4*250)+($5*250)+($6*250)

- $1,500 if intrinsic value used• (($16-$15)*250)+(($17-$15)*250)+(($18-$15)*250)

Grant date: - $2,250= $3*750 options if FV used- Nil if intrinsic value is used

Service date:- $3,750 if FV used

• ($4*250)+($5*250)+($6*250)

- $1,500 if intrinsic value used• (($16-$15)*250)+(($17-$15)*250)+(($18-$15)*250)


Compensation Cost

Compensation Cost Vesting date

- $4,500 = $6*750 options if FV used- $2,250 if intrinsic value is used

• ($18-$15)*750

Exercise date:- $15,000 if FV used

• $20*750• No time value remains when exercised at expiry date

- $15,000 if intrinsic value used• ($35-$15)*750

Vesting date- $4,500 = $6*750 options if FV used- $2,250 if intrinsic value is used

• ($18-$15)*750

Exercise date:- $15,000 if FV used

• $20*750• No time value remains when exercised at expiry date

- $15,000 if intrinsic value used• ($35-$15)*750


Comparison

Comparison

Grant date

Service date

Vesting date

Exercise date

Fair value

$2,250 $3,750 $4,500 $15,000

Intrinsic value Nil $1,500 $2,250 $15,000


Authoritative Bodies

Authoritative Bodies

IASB—International Accounting Standards Board- Principle-based guidance

FASB—US Financial Accounting Standards Board- Rule-based guidance

CICA- Principle-based guidance

IASB—International Accounting Standards Board- Principle-based guidance

FASB—US Financial Accounting Standards Board- Rule-based guidance

CICA- Principle-based guidance


IASB Model (Proposed)IASB Model (Proposed)

G4+1 paper Fair value measurement model Vesting date Variable accounting in interim

periods The type of recipient is

irrelevant

G4+1 paper Fair value measurement model Vesting date Variable accounting in interim

periods The type of recipient is

irrelevant


FASB ModelFASB Model

Employee plans:- Fair value at grant date(rarely used) or- Intrinsic value at measurement date:

• Variable plan accounting: “bad” result• Fixed plan accounting: “good” result

Non-employee:- Fair value- Performance completion date

• Under reconsideration by EITF

Employee plans:- Fair value at grant date(rarely used) or- Intrinsic value at measurement date:

• Variable plan accounting: “bad” result• Fixed plan accounting: “good” result

Non-employee:- Fair value- Performance completion date

• Under reconsideration by EITF


FASB ModelFASB Model

SFAS 123 (1995) APB 25 (1972)

- Numerous practice interpretations

FIN 44 (2000)- Repairs and maintenance project

∽ 20 EITF issues

SFAS 123 (1995) APB 25 (1972)

- Numerous practice interpretations

FIN 44 (2000)- Repairs and maintenance project

∽ 20 EITF issues


CICA ModelCICA

ModelMixed model, depends on award type:

- Non-exempt awards:• SARs settleable with equity instruments

– FV or intrinsic value

• All awards settleable with cash or other assets (includes SARs)– Intrinsic value

• Direct awards of stock– Fair value

• ALL awards to non-employees– Fair value

- Exempt awards: everything else

Mixed model, depends on award type:- Non-exempt awards:

• SARs settleable with equity instruments– FV or intrinsic value

• All awards settleable with cash or other assets (includes SARs)– Intrinsic value

• Direct awards of stock– Fair value

• ALL awards to non-employees– Fair value

- Exempt awards: everything else


CICA ModelCICA

Model Disclosure for exempt awards

- Pro forma net income and EPS (if required)

Effective January 1, 2002 Certain awards

“grandfathered”- Certain “exempt” awards - Non-employee awards granted prior

Disclosure for exempt awards- Pro forma net income and EPS (if

required)

Effective January 1, 2002 Certain awards

“grandfathered”- Certain “exempt” awards - Non-employee awards granted prior


Plans to ConsiderPlans to Consider

Plain vanilla stock option- Time vesting- Performance vesting

SARs Non-employee

arrangements

Plain vanilla stock option- Time vesting- Performance vesting

SARs Non-employee

arrangements


Plain Vanilla Stock Option

Plain Vanilla Stock Option Date of grant: Jan. 1, 20X0

Market price at grant date: $10 Exercise price: $10 Fair value at grant date: $2 Vesting period: 100% at Dec. 31, 20X2 Expiration date: 5 yrs. from grant Number of options granted: 100 EOY market prices: $12, $12, $17, $16,

$24 EOY fair values: $3, $5, $7, $6, $14

Date of grant: Jan. 1, 20X0 Market price at grant date: $10 Exercise price: $10 Fair value at grant date: $2 Vesting period: 100% at Dec. 31, 20X2 Expiration date: 5 yrs. from grant Number of options granted: 100 EOY market prices: $12, $12, $17, $16,

$24 EOY fair values: $3, $5, $7, $6, $14


IASB Model (Proposed)

Fair Value—Vesting Date


Fair Value—Vesting DateYR 1 YR 2 YR 3 YR 4 YR 5

Fair value $3 $5 $7 N/A N/A# of Options

100 100 100 100 100

Cost $300 $500 $700 N/A N/A% vested 33% 66% 100%

Aggregate $99 $330 $700

Prior period

- 99 330

Current cost

$99 $231 $370


FASB ModelIntrinsic Value—Measurement Date:

Fixed Plan


Fixed PlanYR 1 YR 2 YR 3 YR 4 YR 5

Intrinsic value

$0 N/A N/A N/A N/A

# of Options

100 100 100 100 100

Cost $ 0 $ 0 $ 0 N/A N/A% vested 33% 66% 100%

Aggregate $ 0 $ 0 $ 0

Prior period

- 0 0

Current cost

$ 0 $ 0 $ 0



Variable Plan*


Variable Plan*YR 1 YR 2 YR 3 YR 4 YR 5

Intrinsic value

$2 $2 $7 $6 $14

# of Options

100 100 100 100 100

Cost $200

$200 $700 $600 $1,400

% vested 33% 66% 100% 100%

100%

Aggregate $66 $132 $700 $600 $1,400

Prior period - 66 132 700 600Current cost

$66 $66 $568 ($100)

$800

*assume Yr 5 performance condition


FASB ModelFV Value—Grant Date: Equity

Instrument Award

FASB ModelFV Value—Grant Date: Equity

Instrument AwardYR 1 YR 2 YR 3 YR 4 YR 5

Fair value $ 2 N/A N/A N/A N/A100 100 100 100 100

Cost $200 $200 $200 N/A N/A% vested 33% 66% 100%

Aggregate $66 $132 $200

Prior period

- 66 132

Current cost

$66 $66 $68 Rounding


CICA Model

Fair Value—Grant Date

CICA Model

Fair Value—Grant DateYR 1 YR 2 YR 3 YR 4 YR 5

Fair value $2 N/A N/A N/A N/A# of Options

100 100 100 100 100

Cost $200 $200 $200 N/A N/A% vested 33% 66% 100%

Aggregate $66 $132 $200

Prior period

- 66 132

Current cost

$66 $66 $68 Rounding


CICA Model

Opt Out Option

CICA Model

Opt Out OptionDr Cash $1,00

0Cr Share capital

$1,000To recognize receipt of cash upon exercise of stock option by employee


Summary—Plain Vanilla Option

Summary—Plain Vanilla Option

IASB (FV – both plans): $700 FASB (IV - fixed plan): $0 FASB (IV - variable plan):

$1,400 FASB (FV - both plans): $200 CICA: (FV – both plans): $200 CICA (opt out): $0*

IASB (FV – both plans): $700 FASB (IV - fixed plan): $0 FASB (IV - variable plan):

$1,400 FASB (FV - both plans): $200 CICA: (FV – both plans): $200 CICA (opt out): $0**not considered a compensation transaction


Stock Appreciation Rights

Stock Appreciation Rights Date of grant: Jan. 1, 20X0

Market price at grant date: $10 Exercise price: $10 Fair value at grant date: $2 Vesting period: 100% at Dec. 31, 20X2 Payout/Expiration date: 5 yrs. from grant Number of options granted: 100 EOY market prices: $12, $12, $17, $16,

$24 EOY fair values: $3, $5, $7, $6, $14

Date of grant: Jan. 1, 20X0 Market price at grant date: $10 Exercise price: $10 Fair value at grant date: $2 Vesting period: 100% at Dec. 31, 20X2 Payout/Expiration date: 5 yrs. from grant Number of options granted: 100 EOY market prices: $12, $12, $17, $16,

$24 EOY fair values: $3, $5, $7, $6, $14



Fair Value—Vesting Date


Fair Value—Vesting DateYR 1 YR 2 YR 3 YR 4 YR 5

Cash liability

$2 $2 $7 $6 $14

# of Options

100 100 100 100 100

Cost $200

$200 $700 $600 $1,400

% vested 33% 66% 100% 100%

100%

Aggregate $66 $132 $700 $600 $1,400


$66 $66 $568 ($100)

$800



Variable Plan


Variable PlanYR 1 YR 2 YR 3 YR 4 YR 5

Intrinsic value

$2 $2 $7 $6 $14

# of Options

100 100 100 100 100

Cost $200

$200 $700 $600 $1,400

% vested 33% 66% 100% 100%

100%

Aggregate $66 $132 $700 $600 $1,400


$66 $66 $568 ($100)

$800


FASB ModelFV Value—Liability

Award

FASB ModelFV Value—Liability

AwardYR 1 YR 2 YR 3 YR 4 YR 5

Cash liability

$2 $2 $7 $6 $14

# of Options

100 100 100 100 100

Cost $200

$200 $700 $600 $1,400

% vested 33% 66% 100% 100%

100%

Aggregate $66 $132 $700 $600 $1,400


$66 $66 $568 ($100)

$800


CICA ModelIntrinsic Value-Variable

Accounting

CICA ModelIntrinsic Value-Variable

AccountingYR 1 YR 2 YR 3 YR 4 YR 5

Intrinsic value

$2 $2 $7 $6 $14

# of Options

100 100 100 100 100

Cost $200

$200 $700 $600 $1,400

% vested 33% 66% 100% 100%

100%

Aggregate $66 $132 $700 $600 $1,400


$66 $66 $568 ($100)

$800


Summary—SARs

Summary—SARs

IASB: $1,400 FASB: $1,400 CICA: $1,400

- No US/CAD GAAP difference

CICA (opt out): not permitted

IASB: $1,400 FASB: $1,400 CICA: $1,400

- No US/CAD GAAP difference

CICA (opt out): not permitted


CICA vs. FASB

CICA vs. FASB

Plan typePlan type 38703870 3870 3870

opt outopt out APB 25APB 25 SFAS 123SFAS 123Plain vanilla option

FV—grant date

IV—fixed accounting

FV—grant date

Cash SARs

IV—variable

accountingN/A

IV-variable accounting

IV-variable

accounting

Net equity SARs*

FV—grant date

OR

IV—variable

accounting

N/A

IV—variable

accounting

FV—grant date

* Not previously discussed

IV≡Intrinsic value


Other IssuesOther Issues

Allocation period Whose an employee? Forfeitures

- Expiry of options

Modifications--repricing Non-compensatory plans

Allocation period Whose an employee? Forfeitures

- Expiry of options

Modifications--repricing Non-compensatory plans


Recognition of Comp. Cost

Recognition of Comp. Cost

If vesting: over the vesting period- No basis to argue for past services?

Graded vesting vs. cliff vesting- Choice depending on assumptions about

expected life Recognition given to forfeitures

- Estimate or actual forfeitures- Expire unexercised ≠ forfeiture

Capitalize or expense cost

If vesting: over the vesting period- No basis to argue for past services?

Graded vesting vs. cliff vesting- Choice depending on assumptions about

expected life Recognition given to forfeitures

- Estimate or actual forfeitures- Expire unexercised ≠ forfeiture

Capitalize or expense cost


Repricing

Repricing IASB: re-measurement

FASB APB 25: re-measurement and variable accounting until expire, exercise or forfeited- 6 mth look-back/look-forward

FASB SFAS 123: re-measurement CICA: depends:

- 3870 Opt out: no accounting- 3870: re-measurement

• No US/CAD GAAP difference: 3870 & SFAS 123

IASB: re-measurement FASB APB 25: re-measurement

and variable accounting until expire, exercise or forfeited- 6 mth look-back/look-forward

FASB SFAS 123: re-measurement CICA: depends:

- 3870 Opt out: no accounting- 3870: re-measurement

• No US/CAD GAAP difference: 3870 & SFAS 123


Non-Employee Awards

Non-Employee Awards

FASB/CICA: fair value at measurement date:- Earliest of:

• (1) performance commitment date,

• (2) performance completion date, or

• (3) grant date if fully vested non-forfeitable at that date

IASB: fair value at the vesting date

FASB/CICA: fair value at measurement date:- Earliest of:

• (1) performance commitment date,

• (2) performance completion date, or

• (3) grant date if fully vested non-forfeitable at that date

IASB: fair value at the vesting date


Who is an EmployeeWho is an Employee

Under law- Consistently represented as such

Directors for director services

Leased employees- Microsoft phenomenon- Need to participate in benefits

Under law- Consistently represented as such

Directors for director services

Leased employees- Microsoft phenomenon- Need to participate in benefits


Measurement Date

Measurement Date

Probable supplier will perform- Sufficiently large disincentive for

nonperformance• Excludes: forfeiture of equity instruments or risk of being sued• Would continue to perform even though grant worthless• Unlikely anyone would agree to such a penalty

- Matter of judgment Result: measure at

performance completion date- Estimate cost of goods/service in interim

periods: variable accounting

Probable supplier will perform- Sufficiently large disincentive for

nonperformance• Excludes: forfeiture of equity instruments or risk of being sued• Would continue to perform even though grant worthless• Unlikely anyone would agree to such a penalty

- Matter of judgment Result: measure at

performance completion date- Estimate cost of goods/service in interim

periods: variable accounting


Non-Employee Award

Non-Employee Award

1,000 options for consulting services

Performance period: 1 year FVs at EOQ: $10, $8, $14,

$20 Assume no forfeitures

1,000 options for consulting services

Performance period: 1 year FVs at EOQ: $10, $8, $14,

$20 Assume no forfeitures


Cost of Consulting Services

Cost of Consulting Services1’Q 2’Q 3’Q 4’Q

Fair value $10 $8 $14 $20Options 1,000 1,000 1,000 1,000

$10,000*

$8,000 $14,000

$20,000

% complete 25% 50% 75% 100%Accrual $2,500 $4,000 $10,50

0$20,000

Prior period - $2,500 $4,000 $10,500Current period

$2,500 $1,500 $6,500 $9,500

*if fully vested non-forfeitable


Investors’

Concerns

Investors’

Concerns

Information usefulness- Who wants to be an optionnaire???

Dilution/overhang Need for shareholder approval

- Circumvent by repurchase shares in market Repricing

- non-employee shareholders lose when price falls

- 6mth rule—anti-motivational: • want share price to fall in the interim

Information usefulness- Who wants to be an optionnaire???

Dilution/overhang Need for shareholder approval

- Circumvent by repurchase shares in market Repricing

- non-employee shareholders lose when price falls

- 6mth rule—anti-motivational: • want share price to fall in the interim


Nightmare on Dilution Street*

% growth Jan., 1998, through Oct., 2001

Nightmare on Dilution Street*

% growth Jan., 1998, through Oct., 2001

*Globe and Mail

Sales growthSales per

share growthNortel 14% - 26%Cisco 104% 76%

Celestica 222% 6%

Lucent - 40% - 53%

JDS Uniphase 586% 81%


Financial Engineering

Financial Engineering

Intrinsic value method:- Zero intrinsic value plans- No performance conditions other

than time vesting

Non-employee plans:- Fully vested non-forfeitable

• Economic reality???

Intrinsic value method:- Zero intrinsic value plans- No performance conditions other

than time vesting

Non-employee plans:- Fully vested non-forfeitable

• Economic reality???


Cancel/agree to issue new in 6 mths- exercise price = then fair value, or- exercise price set at > $X or then fair value

Replace with restricted stock Grant new at-the-money option

with an expiry date of (1) earlier of a fixed date or (2) 6 mths after stock price reaches the exercise price of the original option

Cancel/agree to issue new in 6 mths- exercise price = then fair value, or- exercise price set at > $X or then fair value

Replace with restricted stock Grant new at-the-money option

with an expiry date of (1) earlier of a fixed date or (2) 6 mths after stock price reaches the exercise price of the original option

Financial Engineering—

Repricing Underwater Options

Financial Engineering—



Financial Engineering —


Financial Engineering —


Cancel; grant new fully vested award with agreement by employee to exercise award- reduces time that new award is

considered variable

Cancel; grant new fully vested award with agreement by employee to exercise award- reduces time that new award is

considered variable

Questions?

Questions?

Stock-based Compensation

Documents

Transcript of Stock-based Compensation