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Monthly Archives: October 2010

October 28, 2010

Deferrals as Risk Management

One of the fundamental principles behind deferring payout on awards is the desire to lessen the potential time gap between the point at which an executive is rewarded for his or her policies and the point at which the company realizes the consequences or benefits of those same decisions. The deferral is one way to help keep executives focused on the long-term impact of business strategy.


As Barbara pointed out in her August 17th blog entry, deferring the payout of shares can be particularly useful when used in conjunction with a clawback provision or to supplement the company’s ownership guidelines. A deferral may also be valuable for performance awards if there is the possibility of a future negative adjustment exists.

With clawbacks and potential negative adjustments on performance award payouts, it can be very difficult to recover shares or income after the fact, even with carefully constructed provisions. If the company must take back vested shares, it is obviously easier to do if the shares have not been disposed of, yet.

Depending on the parameters of a company’s holding requirements or ownership guidelines, it may be advantageous to an executive subject to these policies to also be subject to deferral on certain grants. The deferral may effectively delay the income event out to a point that either coincides with or is closer to the point at which the executive can dispose of the shares.


Of course, any deferral program should be compliant with 409A. However, because there is no deferral election, designing within the parameters of 409A is easier. Another consideration is whether or not the deferral would require, or even be best suited for, a non-qualified deferred compensation program into which the vested shares may be deposited. Visit our Section 409A portal or Bruce Brumerg’s new site,, for more on this issue.

In conjunction with 409A compliance, the general timing of the deferral is a key issue. On one hand, the deferral should be far enough into the future to align the executive’s risk on that potential income with the company’s risk. However, executives are making policy that could impact the company far into the future; there is little incentive for income that is delayed indefinitely. A compromise must be reached to find an appropriate period of time that is effective as a risk-mitigation technique that does not negate the incentivizing power of the reward.


Some RSU programs permit participants to elect to defer the payout of shares to a future date, presumably a time when the participant’s tax bracket is lower than in the year of the original vest. 409A has made elective deferral programs more cumbersome, but they do still exist. A non-elective deferral does not give the participant control over whether or not receipt of the vested shares is deferred. As our panelists in the Conference session “Risk Mitigation for Stock Compensation” pointed out, we are at a point when income tax rates are likely to increase in the near future, which makes deferring income less appealing right now. A company implementing a required deferral of RSU or performance shares should carefully consider how to communicate the program’s goals and application to executives or other employees who will be subject to the deferral.

On a more practical administrative level, deferral of the share payout only defers the income tax withholding requirement. FICA withholding, along with the associated FUTA contribution, are due at the vest date.

Quick Survey on 6039 Returns and Information Statements

Take our quick survey on filing Forms 3921 and 3922 to report ISO and ESPP transactions to the IRS and on distributing the associated information statements to plan participants. Find out how other companies are planning to comply with these new requirements.


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October 26, 2010

Cost-Basis Reporting: Coming Soon to a Broker Near You

Just in the nick of time, the IRS has released the final regulations for cost-basis reporting on Form 1099-B, the first phase of which goes into effect for stock sales occurring on or after January 1, 2011. Thanks to Andrew Schwartz of BNY Mellon Shareowner Services for providing the NASPP with an alert explaining how the regulations apply to stock compensation.

Final Regulations on Cost-Basis Reporting
Andrew’s alert covers the key impacts to stock compensation in just two pages, but for those of you that still don’t have time to read it, I provide a few highlights below.

What the…?

Hopefully this hasn’t caught you by surprise, but, in case it has, here’s a refresher. The Economic Stabilization Act of 2009, as a revenue-raising measure, requires brokers to include cost-basis information on any Forms 1099-B reporting sales of securities (stock, options, etc.)–see our earlier alert “Cost Basis Reporting to Impact Stock Plans.” The requirement is phased in over several years; the first phase, which applies to sales of stock, is effective beginning in 2011.

If you are wondering how this will raise revenue, given that the most common mistake employees make when reporting stock sales on their tax returns is to underreport their basis, so was I. That is until I realized that the way the requirements are phased in for stock compensation is actually likely to increase the likelihood that employees will underreport their basis, at least for the first few years. See my June 2, 2010 blog entry, “Cost-Basis Reporting: Complicating an Already Confusing Topic.”

The Final Regulations

Under the final regulations, as under the proposed regulations, cost basis will have to be reported for any sales of stock acquired on or after January 1, 2011. This includes stock acquired through option and SAR exercises, ESPPs, and restricted stock and unit awards.
The final regulations carve out an exception for stock that isn’t acquired “for cash.” For our purposes, this includes restricted stock and unit arrangements and also most likely SSARs, because employees do not pay cash to acquire shares under those types of awards. For stock acquired under options and ESPPs, where employees are required to pay for the stock, the broker must report a cost basis at least equal to the amount the employee paid for the stock (the cost basis also includes any ordinary income recognized in connection with the stock, but brokers aren’t required to include this in the cost basis until 2013–hence the likelihood for underreporting).

Unfortunately, the regulations don’t do much to address the complications involved in reporting the cost basis for shares acquired under an ISO or ESPP, which often can’t be fully calculated until the shares have actually been sold.

Why Do You Care (If You Aren’t a Broker)?

I know that it feels like this is something that only applies to brokers but the fact is that these requirements are likely to have an impact on stock plan administration, from additional data that your brokers and transfer agents are going to need from you, to employee confusion, to higher fees that brokers and transfer agents are charging to pay for the additional infrastructure necessary to fulfill the reporting requirements. If you haven’t yet discussed these regulations with your brokers (and transfer agents, this implicates them as well), now is the time to have that conversation.

Conference Audio Available
Andrew moderated a great session on this topic at the 18th Annual NASPP Conference, “IRS Cost-Basis Reporting: Are Your Stock Plans Ready?” If you missed it and want to know more about cost-basis reporting, you can purchase the recorded audio for this and any other Conference sessions in downloadable MP3 format. Purchase just the session(s) you want or save by purchasing a package of sessions.

Free Conference Session Audio If You Renew by Dec 31
All NASPP memberships expire on a calendar-year basis. Renew your membership by Dec 31 and you’ll qualify to receive the audio for one NASPP Conference session for free!

Join Now and Get Three Months Free and Free Conference Session Audio!
If you aren’t currently an NASPP member, now is the time to become one! Join the NASPP for 2011 and you’ll get the rest of 2010 for free.  If that’s not enough, you’ll also get the audio for one NASPP Conference session for free. Tell all your friends!

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

– Barbara

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October 21, 2010

SAFE Sales

If your company provides equity compensation to employees in China, then you are likely grappling with the complexity of obtaining and maintaining compliance with your company’s SAFE filing. One important ongoing issue is the requirement that proceeds from the sale of shares be repatriated. China isn’t the only country that has a repatriation requirement. However, it does, to my knowledge, have the most rigorous enforcement of it.

China puts the onerous on the company to repatriate proceeds from the sale of shares acquired through equity compensation programs. In order to maintain compliance, companies need to tackle creating a process for ensuring repatriation.

Immediate Sale

One way to ensure that proceeds from sales are sent back to China is to force an immediate sale of shares at the original acquisition (e.g., at option exercise or RSU vest). By doing this, the company does not need to worry about tracking shares after they are acquired by the employee. Depending on the functionality provided by your designated broker, this approach may also make quarterly reporting easier, which I’ll address below. However, forcing the immediate sale of shares denies Chinese employees the ability to capitalize on any future increase in the value of those shares. Arguably, the value of this arrangement is no more advantageous to the employee than cash compensation that is tied to share value. In addition, the terms of outstanding grants may not give the company the flexibility to require the immediate sale.

Tracking Shares

Many brokers now have the ability to place a hold on proceeds from sales made through specific employee accounts and remit those funds back to a corporate account. This makes it possible for China plan participants to hold shares and sell them at a date of their choosing and still comply with the repatriation requirement. Of course, you will need to confirm that employees can’t transfer the shares out of the employee account at any time, even after termination. You’ll also want to fully understand how employees are identified as subject to the hold and have appropriate safeguards in place to make certain those identification markers are accurate.

Converting to RMB

Regardless of the method in which proceeds from sales are repatriated to China, funds are sent to the company’s bank account in China in U.S. dollars and must be converted to RMB. Your company must decide if this conversion is done by the company or by the employees individually. If the company is transacting the exchange through the dedicated bank account, the RMB can be distributed to the employee through individual bank accounts or through payroll. However, the company may need to receive approval from the local SAFE office for each conversion and there may be limitations on the number of times that the currency may be exchanged each year. If the company will be disbursing U.S. dollars, then employees must have a U.S. dollar account.

Quarterly Reporting

Regardless of your approach, SAFE offices require information about the source of the incoming funds, including the original acquisition date of the shares, to be reported on a quarterly basis. Some brokers have the functionality to provide this data to clients already. At a minimum, you will need to know the total proceeds net of broker fees associated with each employee and the number of shares sold, in which case you must create a policy and procedure on associating the sales with specific acquisitions (e.g. option exercises or RSU vests). Talk with your broker to understand what information can be provided at this time.

Additional Information

SAFE filing and the ongoing compliance requirements can be difficult and time consuming. For more information on equity compensation in China, visit the China Country Guide and alerts on the NASPP Global Stock Plans portal. We also had a fantastic panel at our Conference this year: Equity Compensation in China: Tales from the PRC. To listen to the audio from that session, order your audio package today.

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October 19, 2010

Clawbacks and Executive Compensation

According to the NASPP’s 2010 Domestic Stock Plan Design Survey (co-sponsored by Deloitte, with survey systems support provided by the CEP Institute), 68% of respondents report that their stock compensation programs are not subject to a clawback provision. I’m hearing predictions that this will change, with more companies implementing clawbacks for executive level employees in the future.

Clawback Provisions
A clawback provision enables the company to recover, or “clawback” previously paid or realized compensation upon the occurrence of specified events or behavior. Historically used to enforce noncompete provisions, we are now seeing clawbacks for financial restatements due to misconduct or compliance failures, inaccurate financial reports, and fraud or ethical misconduct (whether or not it results in financial restatement). I’ve even heard of a company including a clawback on performance awards if the board later determined that the way the performance goal was achieved wasn’t quite the behavior they were looking for. Clawbacks can apply to bonuses and various types of stock awards, including stock options, restricted stock/units, and performance awards.

Why Clawbacks Now?

Clawbacks are hot now in part because several recent pieces of legislation have required them, including SOX, the Emergency Economic Stabilization Act, and, most recently, Dodd-Frank. Although the requirements are fairly limited in each case (for example, EESA only applies to TARP companies), regulator interest in clawbacks is likely indicative of the public and media support for them. And now clawbacks are viewed as an effective tool for mitigating risk in compensation programs.

In evidence of how hot clawbacks are today, they were a topic at numerous excellent sessions at this year’s NASPP Conference, including “Key Fixes for Today’s Stock Plans: Clawbacks, Double-Triggers, and Hold-through-Retirement, ” “Risk Mitigation for Stock Compensation,” and “Get the Lead Out: Ten Essential Stock Plan Updates.” Here are some of the things I learned from these sessions.

Implementing Clawbacks

In addition to the obvious questions that must be addressed when implementing clawbacks–who should the clawback cover, what compensation should it cover, what events should trigger it, and how long it should be in effect–there are a number of more sophisticated matters to address:

  • Should the clawback be a provision in the plan or award agreement or should it be a more general policy?
  • Will the clawback be enforceable? State laws can be a particular hindrance to enforcement, so this question is not always as easy to answer as you might think, given that federal laws require clawbacks in some circumstances.
  • How will the clawback be communicated to executives and what level of consent will be required from them (for example, executives have to indicate consent by signature)? If the clawback policy covers previously granted awards, what will the consequences be if executives don’t consent?
  • What level of discretion to enforce (or not enforce) the policy will be provided to the board?

If a company has a clawback policy or provision in place, one tip from the “Risk Mitigation for Stock Compensation” panel is to discuss the policy prominently in the Executive Summary of the CD&A in your proxy statement. Clawbacks are exactly the type of risk mitigation strategy that ISS and shareholders (and other shareholder advisory groups) are looking for; having a clawback policy could offset other problematic compensation practices.

The panel also included a detailed discussion of the tax treatment that applies when a clawback is triggered–information that is likely to be very useful in the future as we see more enforcement of these provisions.

Conference Audio Available
If you missed these panels and want to know more about clawbacks, don’t despair–you can purchase the recorded audio for any and all Conference sessions in downloadable MP3 format. Purchase just the session(s) you want or save by purchasing a package of sessions.

Free Conference Session Audio If You Renew by Dec 31
All NASPP memberships expire on a calendar-year basis. Renew your membership by Dec 31 and you’ll qualify to receive the audio for one NASPP Conference session for free!

Join Now and Get Three Months Free!
If you aren’t currently an NASPP member, now is the time to become one! Join the NASPP for 2011 and you’ll get the rest of 2010 for free.  Tell all your friends!

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

– Barbara 

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October 14, 2010

News From India

New Taxation in India?

Last week while I was thinking about the ongoing issues for companies with equity compensation in India, the Federation of Indian Chambers of Commerce & Industry (FICCI) was considering the ongoing issues for employees. This week, FICCI issued a letter to the finance ministry asking that the taxation of ESOPs (Employee Stock Option Plans) be amended (See the press release here.).

In the proposal, FICCI asks that the discount value at grant, as opposed to the spread at exercise, be taxed as income. FICCI argues that only the discount provided by the company at grant represents the consideration given to the employee by the company; any increase in value after that is more like investment income. FICCI maintains that taxing the spread at exercise as a perquisite is counter to the SEBI guidelines for stock options.

The press release focuses on the section of the SEBI guidelines that stipulates the fair value of an option should not be adjusted for “changes in the price of the underlying stock, volatility, the life of the options, dividends on the underlying stock, or the risk-free interest rate.” Although the FICCI proposal does mention that SEBI guidelines define the FMV of an option as the market price prevalent on the grant date, it fails to mention that this “market price” referenced in the guidelines is actually the trading value of the option, or estimated trading value based on a valuation model (e.g., a Black-Scholes valuation). At any rate, this is merely a request to the finance ministry at this point. It remains to be seen whether or not the finance ministry will even entertain the idea. Because it would probably result in a decrease in tax revenue, my gut tells me no…but stranger things have happened!

Ads by Google: Or, “An ESOP by Any Other Name”

While reading an article on the FICCI proposal, Google ads saw a great acronym and gave me a targeted add for the ESOP Association. Because of that, I learned that October is Employee Ownership Month, which, I must admit, caught me by surprise. Although employee ownership is a foundation for most equity compensation, Employee Stock Ownership Programs (ESOPs) in the United States are specific programs under which shares of company stock are placed in a trust. Shares in the trust are allocated to employees based on whatever parameters have been set up by the company. The allocated shares typically vest over time, but vested shares are not actually issued to the employee until termination.

October has been Employee Ownership Month for more than 20 years; it’s a month set aside to educate the public (not just employees) about the benefits of employee ownership (i.e., ESOPs). According to the ESOP Association, “…companies celebrate with picnics to honor their employee owners, hold roundtable discussions with local public officials and organizations to spread the word about employee ownership, and some hold awards ceremonies to honor outstanding employees.”

So, I searched and searched, but I couldn’t find anyone that celebrates an “Equity Compensation Month.” With the cyclical nature of bad press on equity compensation, I certainly think we could benefit from one. Wouldn’t it be great if companies everywhere celebrated equity compensation at the same time?

If you are looking for more information on ESOPs, the National Center for Employee Ownership (NCEO) is a great resource.


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October 12, 2010

Will Your Termination Procedures Withstand a Lawsuit?

With the year-end quickly approaching, I thought that the final versions of Forms 3921 and 3922 would surely be waiting upon my return from my vacation last week, providing foddor for the NASPP blog (the IRS, along with the SEC and FASB, seem to have a knack for releasing stuff when I’m on vacation).  But, to my surprise, the final forms still aren’t available.  So instead, this week I blog about a recent case in the Maryland Court of Appeals relating to a company’s right to cancel options upon an executive’s resignation, which reminded me of a few best practices to ensure that, when employees terminate, stock awards receive the treatment the company intends.

Forfeiture of Awards Upon Termination of Employment: Not Always As Clear Cut As You Think
The case involved an executive who voluntarily resigned but continued to work while severance negotiations were ongoing. The negotiations failed and the company terminated the executive–just eleven days prior to when his options would have vested. The county court (where the case was initially tried) assigned a value of around $850,000 to the options, presumably based on the spread on the vesting date or the date the executive tried to exercise the options. Given the sum involved, I can only imagine that the eleven days ate at the executive–resulting in his lawsuit claiming that the options were “wages” owed to him under Maryland’s Wage Payment and Collection Law.

To those of us in the business, this might seem like a no-brainer in favor of the company, but the court in which the case was initially tried found in favor of the executive. It all worked out in the end, at least from the company’s perspective, because the appellate court decided against the executive. Even so, lawsuits are expensive, especially those that end up in appeals, so this wasn’t exactly a landslide for the company. The case brings to mind a few best practices.

Dot the I’s and Cross the T’s

Proper documentation is key. This lawsuit is exactly why your attorneys want you to require employees to sign their grant agreements–so that, if necessary, the company can prove that employees knew the terms and conditions of their grants. I’ve read about numerous lawsuits relating to the treatment of stock compensation upon termination and a large percentage of them hinge on whether or not the employee was informed of the vesting and forfeiture conditions.

In addition to having a signed grant agreement, retain copies of any communications to employees that notify them of the terms of their grants and, in particular, any communications relating to their stock compensation that are provided at the time of termination. I’ve read about one case disputing termination provisions where there wasn’t a signed grant agreement on file, but where the subsequent communications that the company was able to produce were sufficient to decide the case in the company’s favor.

Proper documentation is especially important in sensitive circumstances, such as when an executive is leaving on bad terms (as in this case), an employee is terminated for cause, or a reduction in force.

Don’t Be Late

It is critical that stock plan administration receive timely notice of terminations. In this case, the executive actually tried to exercise his options and wasn’t able to because a block had been placed on his account. If the notice of termination had been received just a couple of weeks late, the exercise might have been permitted. Trying to unwind that transaction and force the executive to disgorge the amounts realized on it would have made things infinitely more complicated (and that much more expensive for the company).

Be Prepared

When a reduction in force is planned, it’s a good idea to check for vesting dates that occur shortly after the expected last date of employment. In this case, the employee was voluntarily resigning, so this wasn’t as much of an issue. But where employees are involuntarily terminated, forfeiture of awards that would have vested shortly after their termination date can be problematic. At best, it leaves everyone feeling even worse than they already do. At worst, it can look like the company purposely terminated employees to avoid having to pay out the awards–especially if a large group of the terminated employees had awards vesting on the same date. It might be best to accelerate vesting of the awards in question.

It’s Renewal Time
All NASPP memberships expire on a calendar-year basis. Renew your membership today and avoid the last minute rush on December 31.

Join Now and Get Three Months Free!
If you aren’t currently an NASPP member, now is the time to become one! Join the NASPP for 2011 and you’ll get the rest of 2010 for free.  Tell all your friends!

Don’t Miss Out–Conference Audio Available
If you weren’t able to attend the Conference or did attend but couldn’t get to all the sessions you wanted to (and with over 40 sessions, who could?), you can download the audio from any and all sessions in MP3 format.  Purchase just the sessions you want or save by purchasing a package of sessions.

NASPP “To Do” List
We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog. 

– Barbara 

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October 7, 2010

The Aftermath

India – Life after FBT

We are about half-way through the first tax year in which employers have known the income reporting, tax withholding, and valuation requirements for employees in India. Last year (2009/2010) was quite a scramble, with retroactive updates and guidance being provided late into 2009.


One issue that companies continue to work with is the calculation of FMV, as a Category 1 Merchant Banker valuation is still required for companies not listed on a recognized exchange (Neither NASDAQ nor NYSE are recognized exchanges.). There were several months where it was unclear whether or not Merchant Banker valuations would be required. If your company reported and withheld based on the market value of your stock during the 2009/2010 tax year, you should have adjusted your reporting at this point.


When it comes to Merchant Banker valuations, frequency is still a key consideration (and one that will remain so long as these valuations are required). The regulations state that valuations are only required every 180 days, so it is possible to only value your company’s shares two times a year. However, this may not right for your company, especially if the trading value of the shares has decreased significantly since the most recent valuation.

Double Standard

The difference between the Merchant Banker valuation and the trading value of the stock will remain an ongoing issue regardless of how often your company has a valuation performed. If your stock plan administration software does not permit more than one FMV on a trading date, you may have to provide custom employee communications to accommodate the FMV that was used to calculate income.


Reporting Obligations

Generally speaking, most options and RSU grants in Australia awarded after July 1, 2009 are taxable at vest. There is no withholding obligation for employers, but there is a reporting obligation of Employee Share Scheme (ESS) statements to both the employee and the Australian Tax Office (ATO). They are not unlike the U.S. Section 6039 information statements in theory; presumably they will help employees better understand how to complete their own tax returns and will help the tax authorities determine if income is being properly reported on tax returns, which they will be auditing (See this alert from Deloitte.)


For RSUs, the trading value of the shares at vest may be the FMV for income calculation. However, options are considered an “unlisted right” and might require a valuation method (e.g.; Black Scholes) to determine the market value of the shares on date of the taxable event.

30 Day Rule

One tricky piece of determining the FMV on the taxable date in Australia is the 30 day rule. If an employee sells shares from an RSU vest or option exercise within 30 days of the original taxable event date, then the sale date might be considered the taxable event, provided the company is aware of the sale.


Individual tax returns for the 2009/2010 tax year are due by October 31, 2010. Employees may still be trying to understand the ESS statements provided to them by the company.

Taking Action

Many companies appear to have moved away from granting options in Australia as a result of the reporting obligations. We completed a Quick Survey on this in September; only 20% of respondents were continuing to grant options in Australia, 38% were not granting options to begin with, and a significant 42% were moving to share grants (like RSUs) or some type of cash compensation.


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October 5, 2010

Weighted Averages and Equity Compensation

I bet there was a time (think grade school) when you questioned whether you’d ever use weighted averages in “real life.” Then, surprise, you find yourself in a job where, from the reports you run to the financial disclosures your company makes, weighted averages appear everywhere and you’re expected to understand why and how to use them.

Weighted Averages and Equity Compensation

Common areas where weighted averages are used in equity compensation include:

    • Reporting Section 16 same-day, same-way purchases and sales on an aggregate basis
    • Determining and disclosing shares outstanding for EPS purposes, i.e., basic and dilutive
    • Proxy reporting e.g., Equity Compensation Plan Information
    • Financial statement disclosures, e.g., Stockholders Equity

Weighted averages in plain English, please?

Calculating a weighted average is different than calculating a simple average because some of the values matter more than others in the final equation. Thus, not every value in a weighted average calculation is treated equally; instead, different levels of importance are placed on certain values depending on their weight or worth.


Let’s look at an example to examine how a weighted average is calculated. Assume that a company has two options that are outstanding: option #1 is for 100 shares at a exercise price of $10 per share and option #2 is for 400 shares at an exercise price of $20 per share.

  • Straight Average: To calculate a straight average exercise price, add $10 to $20 and divide by two (because there are two options), to produce an average exercise price of $15 per share.
  • Weighted Average: For a weighted average exercise price, the per share amount is “weighted” by the number of shares in the associated option. To calculate this average, add $1,000 ($10 x 100 shares) to $8,000 ($20 x 400 shares), then divide by the total number of shares outstanding, or 500 shares. The resulting average is $18 per share, three dollars higher than the straight average because the option for more shares carries more weight in the calculation. This raises the average because the option has a higher exercise price than the smaller option.

Why Weightings?

Weightings are important in mathematics because averages can be disproportionately impacted by extreme values. While weighted averages aren’t immune to this, weighting the average at least ensures that the largest items in the data set have the greatest impact on the average value.