Binomial lattice model
An alternative way to value stock options which uses company experience in lieu
of market averages.
Blackout period
A period of time, normally preceding release of company earnings or other significant
data, and during which pension fund investments may not be altered, during which
insiders may not buy or sell shares.
Black-Scholes Model
An accounting model used to value stock options based on prior average experience
of options. Factors used in the model include share price volatility, risk-free
interest rate, dividend yield, forfeiture rates, and a suboptimal exercise factor.
The result is stated as a percentage of the current share price and has typically
ranged from 33-45%. Hence an option on a stock with a market price of $40, and a
Black-Scholes factor of 35%, would be valued in financial statements at $14.
Benefits
Non-cash or cash-deferred remuneration such as medical insurance, vacation or retirement
plans.
Dilution
The effect whereby paying executives with additional stock (including stock options)
increases the total stock outstanding for a company and thereby the percentage of
the company held by another stockholder.
Double Trigger
In the change-in-control context, "double trigger" means that in order for the executive
to receive the change-in-control amount, there must be a change-in-control and the
executive must lose his or her job.
Equity -based compensation
Pay which takes the form of company stock or that varies with the stock price. Equity
pay is frequently used as a long term award for executives since it aligns executive
reward with an increase in shareholder value. Equity pay is also used in many startup
operations which lack cash to attract executive or technical talent.
Equity compensation valuation
Statement of Financial Accounting Standards 123R (FAS 123R) requires evaluation
of restricted stock or option grants using one of several models for estimating
the fair value of the grants as of the grant date. These estimated values are charged
as an expense and reported in the Summary Compensation Table of proxy statements,
but do not reflect actual realized value of the equity compensation. See Black-Scholes
Model or Binomial Lattice Model.
Exercise (or Strike) price
The price at which an option allows the holder to purchase a share of stock. The
strike price is normally the market price on the date that the option is granted.
Premium priced options set a strike price above the market price on the grant date.
Fair value
Alternate term for equity compensation valuation. Also see Black-Scholes or Binomial
Lattice Model.
Golden parachute
Payment to senior executives awarded due to a merger or sale, usually when the executive’s
position is lost due to the change.
Grant date
The date when an equity award, such as stock options, is made to an executive.
Incentive compensation
Pay for executives or other senior staff for achievement of specified company objections
or for increase in shareholder value.
Insider
An individual who has access to information about a company which is not generally
available to the public. Senior executives are always considered to be insiders.
Nonqualified stock (or option)
Award of stock or stock options which are not included in an approved incentive
compensation program or as part of an Employee Stock Option Plan. Result in different
tax treatment for both the recipient and company.
Pay for performance
A term used to define the expectation that executive pay in the form of annual bonus
and long term incentives should correspond to company performance in the market
place as measured by returns to shareholders relative to its peers.
Perquisites or 'Perks'
Personal benefits given to executives, such as financial planning, which are in
addition to standard company benefits available to salaried employees.
Premium priced stock options
Stock options which have a strike or exercise price above the market price on the
date of the grant. Premium priced options are used to encourage superior performance
by requiring greater stock price increases to make the option of value.
Proxy statement
An SEC and stock exchange required discussion of issues to come before a shareholder
meeting and providing the opportunity for shareholders to vote on these issues.
Proxy statements are required to present an extensive discussion of executive compensation
and provide a vote on equity pay plans or changes thereto, along with election of
Directors, selection of Independent Auditors and issues proposed either by the company
or shareholders.
Restricted stock
Grants of stock that have restrictions such as vesting periods or other performance
requirements before they are owned by the recipient.
Say on pay
Proposals whereby shareholders are permitted to vote annually on the total compensation
received by senior executives. Shareholders have proposed Say on Pay proposals for
a vote at annual company meetings and are seeking legislation in the US Congress
mandating such a vote.
Stock Options
A stock option gives the holder the right to purchase a share of company stock at
a particular price for a set period of time, usually 10 years. The price at which
the options may be "exercised" is usually the price of the company’s stock on the
date the options are granted. If the company performs well, the stock price will
increase over the exercise price, giving the options value and rewarding the executive
for his role in the company’s success. Typically, such options may not be exercised
for a period of time, usually between one and five years, before they "vest," or
can be exercised.
As an example, assume an executive is awarded 5,000 options, based on the current
stock price of $30 per share, and vesting in three years. If the executive were
to leave the company within the next 3 years, the options would be lost. After 3
years, the options are vested and the executive could exercise them – or exchange
the options for actual shares of stock by paying the $30 exercise price -- at any
time thereafter. If the stock has by that time risen to $50 per share, the executive
could exercise all 5,000 options by paying $150,000 (5,000 times $30), but the shares
would have a value of $250,000. Hence the executive would actually earn $100,000
if he could immediately sell the shares.
On the other hand, if the stock price has fallen to $25, the options are termed
"under water" and have no value. Who would exercise an option at $30 when the stock
can be purchased on the market for $25? This happened to many options during the
stock market decline in 2001 and will reoccur in each market slump. With the extraordinary
growth in the U.S. economy, large American companies and the stock market (the Dow
Industrials rose from 1,000 in 1980 to 14,000 in 2007), stock ownership has been
most rewarding and stock options granted to corporate executives have paid huge
rewards.
There are many variations on the basic stock option incentive, including performance
vesting, in which the company must achieve specified results for the options to
vest, or premium priced options, in which the exercise price is higher than the
stock price on the date of the grant.
Section 162(m)
A section of the U.S. tax code, adopted in 1993, which limits corporate tax deductions
for executive compensation for the CEO and each of the top four other most highly
compensated executive officers to $1 million annually unless the compensation is
considered 'performance-based.' The provision is regarded by all sides as a failure
at limiting executive compensation.
Section 280G
A section of the U.S. tax code, adopted in 1988, designed to limit the size of "golden
parachute" payments made to executives in the event of a change-in-control of the
company. Section 280G imposes a 20 percent excise tax on parachute payments that
exceed 2.99 times the average taxable cash compensation over the last five years.
Despite its aims, Section 280G established 2.99 times base and bonus as the standard
change-in-control amount.
Severance pay
cash pay to employees when dismissed without cause or due to a substantial reduction
in duties ("for good reason"). Severance is normally seen as compensation to bridge
the time until a new job can be found.
Share ownership guidelines
Requirements set by the Board of Directors that executives must own a minimum number
of shares of stock in the company. This provision is to assure executives’ and shareholders’
interests are aligned.
Share retention requirements
Provisions that require executives to retain shares received through option or share
grants for a period of time after options or equity awards are exercised before
they can be sold.
Stock appreciation rights (SAR)
A type of equity-related compensation in which the recipient receives pay that represents
the increase in the company’s stock price over a specified period of time. Like
stock options, SARs have a strike price, a vesting period and carry a certain term.
For example if a 500 unit SAR is granted when the current stock price is $30, and
if after a 3 years vesting period, the price has risen to $50, the SAR would pay
the $20 increase times the number of units or a total of $10,000. The payment could
be either in cash or stock.
Summary compensation table (SCT)
A required table in the company’s annual proxy statement setting forth pay for the
CEO, principal financial officer and the top three other most highly paid executives
of publicly traded companies.
Targeted compensation
The process whereby a Compensation Committee seeks to target the amount to be earned
by an executive. A typical target would be for base salary to match a peer group,
annual incentive target at 100% of base salary, and long term incentive value of
400% of base salary.
Vesting requirement
The amount of time or the level of performance required before an individual has
an unconditional right to exercise a stock option or SAR or sell restricted stock.
Vesting can be "time based", such as three years, or "performance based" in which
some other objective must be met before the benefit is vested. Time vesting can
be "graded" such as having 25 percent of granted stock options vest per year for
4 years or 'cliff' vesting when 100% is vested after a period of time.