34
Benefits and Beyond, C. 11 Equity Benefits Thomas E. Murphy 1 Thomas E. Murphy 30 November 2010
Thomas E. Murphy 1
Benefits and Beyond, C. 11
Equity BenefitsThomas E. Murphy
30 November 2010
Thomas E. Murphy 2
You own the company!
30 November 2010
Thomas E. Murphy 3
Our employees own the company. (Avis Car Rental)
Could this be the ultimate link among leaders, employees, and owners?
Focused application of the Agency Theory Aligning Total Shareholder Return between
traditional and employee shareholders New strategy: “attitude of ownership.”
Background
30 November 2010
Thomas E. Murphy 4
What’s the down side?
But . . . . It can be powerful
Line of Sight Dilution Stock needs large
public ownership to exploit market dynamics.
During market slides, it could have reverse effect on employees.
30 November 2010
Thomas E. Murphy 5
Lyle Everingham – in W. Virginia
30 November 2010
Thomas E. Murphy 6
401(k) included company stock. Matches are often made in company stock
Kroger grew in employee ownership from 1% to 33% in 3 years with its 401(k).
Profit Sharing Retirement Plans included company stock and provided good accumulation of wealth. (P&G)
ESOPs are totally company stock based.
Retirement Plans and Stock
30 November 2010
Thomas E. Murphy 7
Discount Stock Purchase Plans (with “DRIPS.”)
Brokerage fee free stock purchase plans Stock option plans Restricted stock and Restricted Stock Units Stock Appreciation Rights (SARs) All of these can lead to substantial wealth
accumulation
Other Plans – A U.S. Culture
30 November 2010
Thomas E. Murphy 8
Alignment!
30 November 2010
Thomas E. Murphy 9
U.S. companies prefer variable compensation plans.
U.S. companies want “balance” in their rewards: short term (cash); mid-term (annual bonus); long term (stock and stock options)
Equity can provide an opportunity to pay less than the market in cash compensation.
Equity can be a factor in recruitment and retention.
Rationale
30 November 2010
Thomas E. Murphy 10
Balance – short, medium and long term reward plan
30 November 2010
Thomas E. Murphy 11
Equity can provide an opportunity for a new level of employee communication.
Equity should not be reserved for “executives only.”
More companies have gravitated toward broad based stock, restricted stock, and options plans.
What about the “global” use of equity? The U.K. is an exception, but inhospitable tax and policy treatment in EU.
Rationale
30 November 2010
Thomas E. Murphy 12
What are they?
30 November 2010
Thomas E. Murphy 13
Grantee can buy stock at market price on date of grant (the “strike price.”)
Options can be exercised when vested. Vesting can be graduated or cliff. Vested options can be exercised over their
term, which is usually 10 years. Options are often granted annually. The “option spread” is taxable (ordinary
income) to the grantee when exercised.
What is a Stock Option
30 November 2010
Thomas E. Murphy 1430 November 2010
The “strike price and the spread”
Thomas E. Murphy 15
Incentive Stock Options (ISOs) are not taxed until the recipient sells the exercised stock.
NQSOs are taxed on exercise. Typical exercise: see page 337. What is a stock swap: see page 338. What is a “cashless exercise?” Why would a
company offer these? See page 338.
Stock Options – Mostly NQSOs
30 November 2010
Thomas E. Murphy 16
As compared to shareholder? No money down.
If stock price goes down, no actual loss to Optionee.
Except lower total reward
Employer’s costs
Allocation of Risks – Big Jump?
30 November 2010
Thomas E. Murphy 1730 November 2010
Options require large grants!
Thomas E. Murphy 18
Options are compensation; therefore, they should be taxed as income. But, when and at what value?
When there is a spread? When they are exercised? When they are granted? Note the cost of dilution: cents per share (at
page 340 of the text). What about the discount value of options as
a method to value? (The time value of money)
Costing Options
30 November 2010
Thomas E. Murphy 19
FASB and No. 123R. Must be charged “their fair value” at grant.
One method is the Black Scholes formula which considers term of grant, grant price, volatility of price, and other factors to estimate their value at grant.
This represents new expense for companies, and caused some employers to re-think offering options. The charge against earnings could be significant.
Cost of Options
30 November 2010
Thomas E. Murphy 20
What happens when the market price of the stock is below the strike price?
“underwater options”
Is the notion of an “ownership society” in trouble due to the bear market of 2008 and 2009?
Deep Thoughts . . .
30 November 2010
Thomas E. Murphy 2130 November 2010
Restricted Stock – less costly?
Thomas E. Murphy 22
No stock is actually issued. No dividends and no voting rights are
available, except in some cases the employer can pay a cash equivalent of the dividend.
They are an unfunded promise to issue a specific number of shares when the restrictions lapse.
Taxed upon vesting. Withholding can occur by simply reducing the number of shares delivered.
30 November 2010
What are RSUs? Same as RS except:
Thomas E. Murphy 23
RS and RSUs provide added advantages There is less dilution? Granted in similar fashion. For RS, grantee can make an §83b election. Charge to earnings at grant – but known
value. Query: do restricted stock grants represent
lower risks to employees? (See page 342)
RS and RSUs
30 November 2010
Thomas E. Murphy 24
What are Stock Appreciation Rights? What are their design features? What about dilution? What are the risks? How are they expensed and taxed? How are they “paid off?” See illustration at page 343
Other Equity Grants
30 November 2010
Thomas E. Murphy 25
Do they affect behavior?
30 November 2010
Thomas E. Murphy 26
Do they really motivate and change behavior?
How are they abused? Mega grants and back dating.
How significant is the dilution problem? Line of Sight and “Pepsi Share Power.” What are the employer’s choices if the
options granted are “underwater?”
Some Problems with Equity
30 November 2010
Thomas E. Murphy 27
Maintain the grant and hope for an increase in price.
Option holders turn in their options and are given a “scrap value.”
Options are turned in and new ones are issued in their place at the lower, current market price. (or exchanged for RSUs)
Options are simply re-priced with a lower strike price, or are “backdated.”
The Choices for Underwater
30 November 2010
Thomas E. Murphy 28
Do they get any of these opportunities? How do you think they react to the choices
in the previous slide? So, what is another approach to equity that
might really affect behavior and satisfy the interests of shareholders?
What about shareholders?
30 November 2010
Thomas E. Murphy 29
A different trigger – performance based vesting!
30 November 2010
Thomas E. Murphy 30
Link vesting to the attainment of certain performance standards.
What standards? Total Shareholder return? Earnings per
share? Profits? Sales increases? EBITDA targets? Market share improvements? Indexed stock price increases, unit performance, department performance, individual performance?
Performance Based Equity
30 November 2010
Thomas E. Murphy 31
There is an issue concerning the accounting treatment of performance based equity?
How are they charged to the financial statements?
What impact does it have on the previous stated “abuses?”
How do they work? See example at page 349.
Performance Based Equity
30 November 2010
Thomas E. Murphy 32
Does employee ownership cause them to “think like owners?”
What should be the elements of a “culture of ownership?”
How would you design and evaluate such a program?
See: Van Meter Co. at page 351. Effectively communicating the things within their line of sight that affect the stock price.
Does it work?
30 November 2010
Thomas E. Murphy 33
The concomitant opportunity
30 November 2010
Thomas E. Murphy 38
Pay lower fixed compensation.
Communicate with employees on a higher level.
Opportunity to engage employees in the affairs of the business
The Power Potential of Equity to Create Team-Based Alignment!
30 November 2010
