Considerations for Share-Based Payments – The Complexity Grows

New standards adopted through FAS 123, meant to increase transparency and more clearly reflect the costs of employee compensation, have created greater complexity in evaluating the equity component of compensation plans and the implications for both the employer and the employee. In this CEO Topic, we take a brief look at a few of the many considerations in the ongoing evaluation, accounting and administration that is necessary to determine the most appropriate share based plan for your company and your employees.

Stock ownership as part of a compensation package has always been considered integral to aligning the interests of a company’s executives with its shareholders. The cost of providing this benefit, previously recognized in pro forma footnote disclosures, now has a visible impact on financial statements as an expense item thereby reducing net income and earnings per share. While some foreshadowed the demise of stock options with FAS 123, it appears that rather than abandoning stock options, companies are more carefully considering the amount and the proper mix of share based programs including stock options, restricted stock, restricted stock units (RSU) and other forms of equity compensation.

Tax, accounting and valuation treatments can differ greatly according to the type of equity award. Therefore, plan designs are critical to determining the quantity, timing and recognition of compensation cost. Tax considerations for the individual may vary considerably, and depending upon the type of equity program, carry the risk of being financially onerous. Certain types of equity awards may or may not be appropriate for use in global corporations. It is essential to assess the costs and risks versus the intended benefits of alternative design plans to determine the right share based plan for different levels of employees.

Similarly, the potential impact on a company’s financial statements depends on which share based system is used, the vesting program and the valuation methodology. Performance vesting is a trend that merits consideration. The accounting treatment for performance based equity awards will differ depending on what is used as the basis for measuring performance; whether performance is linked to stock price versus being tied to company operating performance. Financial modeling and analysis can forecast possible outcomes and effects on financial statements so that management and the board can properly assess the risks.

Due to SEC rule 409A, the bar for establishing valuations with regards to equity pricing has become more stringent. The process by which companies price their options and other equity instruments is non-trivial and necessitates a more frequent and systematic approach. Companies need to develop a valuation approach that encompasses arm's length transactions, independent valuations and/or an internal valuation methodology. A combination of these three components will determine the appropriate internal valuation process to be consistently and regularly applied.

New accounting and regulatory standards underscore the need to build knowledge across the broader range of individuals within a corporation. Financial executives who need to be well-informed include members of the compensation committee, the chief financial officer, controller, tax director and the stock-plan administrator. Even non-financial executives and experts such as the human resources director, general counsel, information systems staff and investor relations professionals must be knowledgeable about rules and requirements. External advisors are often vital in assessing best practices and ensuring the proper outcomes.

FAS 123 standards and resulting consequences are increasingly complex. The trends in how companies are addressing these standards continue to evolve. At GA, we can be helpful in discussing the wide-ranging ramifications of FAS 123, associated regulations, valuation methodologies and trends on plan design. Please contact your GA team for further guidance and more in-depth discussion of this increasingly complex topic.