2
PRELIMINARIES
“Workshop” means we want you to participate
I talk a lot and prepare too much material
My experience is mostly with for-profit, public - or soon to be public - companies
3
TOPICS COVERED
1. Option accounting just got more complicated
2. Old economy companies have been losing to new economy companies, but this may change
3. Retaining high-performers is harder than ever
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TOPICS COVERED (cont’d.)
4. Investors are pushing back on high stock-grant dilution
5. Rescuing underwater options is difficult, not impossible
6. There are innovations and trends to watch
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FASB Interpretation No. 44
BACKGROUND
Released 3/31/00
Clarifies APB No. 25
-- accounting rule for employee stock grants
-- specifies “Measurement DatePrinciple”
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FASB Interpretation No. 44
EMPLOYEE DEFINITIONCovered by APB No. 25Yes No Maybe
Common Law/Payroll Tax Test
Board of Directors
Board of Advisors
Consultants/Independent Contractors
Leased Employees
Employees of Other Companies
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FASB Interpretation No. 44
CHANGES IN STATUS
Post-Termination Relationshipwith Former Employer
New Measurement Datefor Post-Termination
Option Vesting
None No
Outside Director No
Advisory Board Yes
Consultant/Independent Contractor Yes
Leased Employee Yes
Employed by Fully Divested Unit No
Employed by Partially Divested Unit Yes
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FASB Interpretation No. 44
OPTION MODIFICATIONS
NewMeasurement
DateVariable
Accounting
Extend Post-TerminationExercise
Accelerate Vesting
Reprice/Reissue Lower-PricedGrants*
Add Reload Feature
* Expense applies to new grant within 6 months (either side) of repricing or reissuing higher-priced option
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FASB Interpretation No. 44
SHARE REPURCHASES
No expense for repurchases more than 6 months from share issuance
No expense for stock-for-tax option withholding
-- but only up to minimum statutory rate
-- new measurement date if exceeded
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FASB Interpretation No. 44
EFFECTIVE DATES
All expense recognition prospective after effective date . . .
12/16/98 for repriced options and grants to nonemployees
1/13/00 for adding reloads
7/1/00 for other
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Oldcos v. Newcos
COMPETING PAY MODELS
Relative ComparisonOldcos Newcos
Annual Cash High Low
Benefits High Low
Stock Options Low High
More attractive in rising stock market
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Oldcos v. Newcos
CANDIDATES’ RESPONSE
More risk adverse
Want additional cash
Will trade-off options for restricted stock, SERPs, deferred annuities, forgivable loans, etc.
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Oldcos v. Newcos
RECENT INITIATIVES
Tracking Stock (Disney, DLJ, Quantum, Staples)
Spinoffs/IPOs (AT&T, GM, HP, Lucent)
Subsidiary Options (?)
Venture Capital Incentives (Merrill Lynch, ?)
Oldcos are creating leveraged pay opportunities from within . . .
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Retention
REASONS FOR PROBLEM
High demand
Longest bull market
High mobility and
accessible information
Options and other equity
compensation prevalent
Recruiting premiums
and buyout packages
Stock price is major
determinant ofcompensation value
“Star” system
Labor Market Stock Market
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Retention
CARLY FIORINA EXAMPLE
From To
Company Lucent Hewlett-Packard
Position Group President,Global ServiceProvider Business
Chief ExecutiveOfficer
Compensation $70M of unvested options forfeited at termination
$100M signingpackage
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Retention
DESIGN PROVISIONS
Option Claw-Backs (Cigna, Delta, Goodyear, IBM)
Tandem Option Guarantees (Amazon)
Stock Purchase Loans (eBay, Excite@Home, Kodak)
Career Restricted Stock (Coca-Cola, GE, 3M)
Forfeitable Deferral Premiums (Alcoa, Dell, GM)
Beyond the traditional . . .
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Dilution
UPWARD TREND
% Total Outstanding SharesU.S. Top-200 Companies*
1989 1999
Share Usage 1.1% 2.1%
Potential Dilution 6.9% 13.7%
* Source: P. Meyer & Partners
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Dilution
INFLATIONARY FACTORS
More pay for performance
-- support shareholder value strategies and ownership objectives
Expanded participation
Companies buying back shares
Non-shareholder approved grants
Illogical grant guideline approach
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Dilution
2000 VOTING; ISS
Opposed majority of plans ( 55%) with limited impact on outcome, but still a concern
Continued flaws in model
-- overvalues grants at high performers and vice versa
-- penalizes omnibus plans without limits on outright grants
-- discourages break out from low utilization industry groups (e.g., utilities, defense, etc.)
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Dilution
2000 VOTING; OTHERS
Same basic guidelines, usually applied on fully diluted basis
Fidelity (FMR) opposed to restricted stock and performance shares without minimum 2-3 year vesting
Large Cap Small Cap
> 15% > 20%
10-15% 15-20%
<10% <15%
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Dilution
LOOKING AHEAD
NYSE may limit broad-based exemption
Efforts needed to encourage improved investor voting rules, especially ISS
%-of-salary option grant guidelines no longer useful
-- need to start with competitive total share usage %, and use surveys for allocation
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Underwater Options
IF SHARES AVAILABLE
Front-load future grants
Next 2-3 years
Incentive for price recovery and retention
No additional “competitive” compensation value
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Underwater Options
IF SHARES NOT AVAILABLE
Executives voluntarily cancel
Company buys back for restricted stock or cash
-- at fair value (i.e., Black-Scholes)
-- discount from fair value
New option grants could be made after 6 months with no variable accounting expense . . .
25
Innovations/Trends
ASCENDING; OPTION RELATED
Opportunistic grant timing
Offset guarantees
Reloads
Automatic vesting acceleration at termination except cause or voluntary quit
Price thresholds for exercise
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Innovations/Trends
ASCENDING; OTHER
Double-trigger change in control stock vesting
Personal loans
-- forgivable and non-forgivable
Flexible deferrals
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Innovations/Trends
DESCENDING
Performance options
-- premiums, indexed, and performance accelerated
Stock purchase loans (except start-ups)
Non-shareholder approved stock plans?
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