For today’s blog entry, I discuss five considerations to keep in mind if you are modifying equity awards.
The accounting treatment of modifications hinges on whether the awards were probable of vesting before the modification and are probable of vesting after the modification. Under ASC 718, most modifications are classified as either Type I (probable to probable) or Type III (improbable to probable).
Accelerating vesting upon termination or making performance targets easier to achieve are generally Type III modifications. The expense for these modifications is equal to the aggregate fair value of the modified award at the time of the modification.
Repricings and option exchanges are generally Type I modifications. For these modifications, calculate the amount by which the aggregate fair value of the grant after the modification exceeds its fair value immediately before the modification. This is the “incremental” cost that must be recognized on top of the expense that was determined for the options when they were originally granted.
In the NASPP webcast “Virus, Volatility and Variables,” Robert Purser does a great job discussing the types of modifications that might be made to equity awards and how they are accounted for (skip to 39:00 to hear his discussion). If you aren’t an NASPP member, click here to access the webcast.
Repricing and option exchanges generally require shareholder approval. Most other modifications, such as acceleration of vesting or modifying performance targets generally do not require shareholder approval. This can vary by plan, however; be sure to review the terms of your plan.
Modifications that require award holders to give up existing rights under their awards will generally require consent from the holders. For example, if award holders must accept extended vesting or a reduced number of shares to participate in a repricing, they’ll need to consent to that. Likewise, if a modification could result in loss of preferential tax treatment, consent may be necessary. Acceleration of vesting seems great, but if it will cause an ISO to exceed the $100,000 limit, the option holder might not be so keen on it.
Many modifications are subject to disclosure, especially if named executive officers or Section 16 insiders are involved.
Most stock options and performance awards granted prior to November 2, 2017 are still exempt from the limit on corporate tax deductions for compensation paid to executives under Section 162(m). Materially modifying these grants, including making the performance targets easier to achieve, paying out the awards when the targets haven’t been met, or repricing options will likely make them ineligible for grandfather protection and thus subject to the Section 162(m) deduction limit.
I’ve created a handy chart that summarizes the key considerations for common modifications to awards. And be sure to check out the rest of our COVID-19 Resources.
7 Things to Know about Leaves of Absence and Equity Awards
Equity awards are intended to compensate employees for the work they do for the company; employees who are on leave aren't working, so it seems reasonable that leaves might affect both eligi...Read More
Accounting for Accelerating Service Conditions of Performance Awards
This week, I return to my series&...Read More
Optimizing Equity Awards in a Down Market
Can equity awards be optimized for insulation against market declines? If 2020 is teaching us anything, it’s that companies may need to get creative in figuring out how to restore broken i...Read More
Equity Design Ideas to Align Outcomes with Objectives
Current market and economic conditions combined with new ways of working are triggering questions on how to approach various aspects of equity – things like how to set and adjust perf...Read More
4 Ways Equity Awards Can Help Cash Flow
Sure, the S&P 500 has almost recovered from the nosedive the market took back in February and maybe your stock price has as well. That’s good news for your shareholders (and your equit...Read More