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5 Things to Know About Award Modifications

March 27, 2024

When it comes to deciding on whether or not you should modify an equity award, there are a plethora of factors that need to be taken into account during this process.

In this article we'll be discussing five things that you need to be factoring into your decision making process!

1.  Most Modifications Have a Cost

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, there are four types of modifications, though most are classified as either Type I (probable to probable) or Type III (improbable to probable)

  • Type I - probable to probable
  • Type II - probable to improbable
  • Type III - improbable to probable
  • Type IV - improbable to improbable

Accelerating vesting upon termination or making performance targets easier to achieve are generally Type III modifications as vesting is now more likely to occur. The expense for these modifications are equal to the aggregate fair value of the modified award at the time of the modification.

Repricing and option exchanges are generally Type I modifications because while they may encourage participants to exercise their awards, these modifications generally do not effect the likelihood of vesting. 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.

2. Shareholder Approval May Be Required

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; so please be sure to review the terms of your plan documents.

3. Award Holders May Need to Consent to the Modification

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.

4. Many Modifications Trigger Disclosure Requirements

Many modifications are subject to disclosure, especially if named executive officers or Section 16 insiders are involved.

  • Under ASC 718, all material modifications that occurred during any year presented in the P&L must be discussed in the notes to the company’s financial statements.
  • Repricings are reportable on Form 4 for Section 16 insiders, as are extensions of the contractual term of stock options.
  • Most modifications made to grants held by named executive officers will need to be discussed in the CD&A and may require additional disclosure in the proxy statement.

5.  Don’t forget Section 162(m)

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.

Additional Information

For those in need of further information, please check out the NASPP webcast “ The Truth about Modifications - Equity Awards & ASC 718,” 

Modifications can be scary in the world of financial reporting and our panel of experts will be providing you with the knowledge needed to confidently tackle any type of modification!

Key Questions to be Answered

  • What constitutes a modification? And how do you identify the various types of modifications (Type I - IV)? 

  • Will your modification create incremental costs?  

  • How do modifications impact expense accounting? 

  • What impact will your modification have on fair value? 

  • Head shot of Jason Mann
    By Jason Mann

    Content Director