10 - Long-Term Incentives— Part III Flashcards
Objectives of an ideal long-term incentive plan include the following:
- (a) It identifies with the _______.
- (b) It coordinates with individual _____.
- (c) It correlates with _____ performance.
- (d) It correlates with ______ performance.
- (e) It is easily _____ by all.
- (f) It requires no special _____ setting.
- (g) It ties the high performer to the company.
- (h) It has no _____ charge.
- (i) It has no _____ to shareholder equity.
- (j) It is ______ to the company.
- (k) It is not taxable to the individual.
- (l) If taxable, it is tax-deductible to the individual.
- (m) It requires no _______ by the individual.
- (n) It has no downside risk for the individual.
- shareholder
- performance
- group
- corporate
- understood
- target
- earnings
- dilution
- tax-deductible
- investment
Describe threshold, target and maximum objectives of long-term incentives.
Long-term incentives typically set threshold, target and maximum objectives. Target is the expected performance outcome for fully ______ performance. Although there may be some difficulty in meeting target, it is believed to be fully attainable.
- Threshold is the first payment above ____. While it is the minimum performance expectation, it is not considered a satisfactory result.
- Maximum is the performance beyond which it is believed there was something working positively outside of the recipient’s ______.
These objectives are often expressed as a probable degree of ______. In other words, what is the probability of hitting the threshold, target and maximum? For the target value, it may range from a 50/50 probability to a 40/60 probability, with the latter being the more aggressive approach. The threshold probability may range from 80/20 to 90/10, and the maximum probability from 10/90 to 20/80. Some plans use reciprocals to set the threshold and maximum. If the degree of difficulty cannot be quantified and explained to participants, reciprocals are more easily accepted than other values.
If peer group measurements are included, they could be any from the list in Question 2, but the two most prevalent are _______ and __________. However, market indicators are usually included only in corporate-level plans. If the plan is not at the corporate level, it means the removal of market value indicators. If non nancial targets are included, likely candidates would be customer satisfaction, product quality and project results. Internal measurements also include a target, threshold and maximum.
- satisfactory
- zero
- control
difficulty
total shareholder return and earnings per share
explain long-term incentives in terms of eligibility.
_______ plans typically extend further down in the organization than other forms of long- term compensation. Some plans include everyone in the organization. The idea is to promote ownership and a closer relationship to shareholders. This can create significant dilution issues and a major charge to earnings.
The problem with any eligibility definition is the pressure it puts on the ____. If salary determines eligibility (e.g., $100,000), it will be unlikely to find anyone earning between $95,000 and $99,000. If grade is the determining factor, don’t be surprised to find there are no jobs in the next lowest grade. If it is job title, stand back for the flood of _____ requests. If it is organization level, how does one resolve the inequity of including a third level assistant to and excluding a fourth level general manager?
One definition that might not create as much internal pressure is elected corporate officer, if such status limits the individual in buying and selling company stock. It is a great ego boost to be an elected corporate of cer, but it comes with heavy restrictions that can be costly, not simply cumbersome.
One possible way to minimize pressures is to pick a combination that seems appropriate. Another alternative is to make the determination totally discretionary, alleviating many of these pressures.
Another consideration is how to handle promotions and demotions. _______ is a good solution, since it diminishes problems of over- and undercompensation in the interim until an adjustment can be made. Persons promoted should be put into the higher schedule at the time of their promotion. The portion of time in the higher grade would determine the portion of the difference between the two payments for the period in question.
Stock option
cutoff
retitling
Prorating
explain the plan period for long-term incentives.
Most stock options are for ___ years since that is the maximum period permitted for statutory stock options, and nonqualified options are often granted for the same time period. Because of an extensive charge to earnings for stock options, a company might opt for a shorter period, such as five or seven years. Stock appreciation rights are typically for the same period of the underlying stock option or, more commonly, for the option they are _____.
Stock award plans are usually half the duration of options or less. Performance share and unit plans are typically three to five years in length. A ______ company might opt for the longer period to allow time to achieve return on investment.
ten
replacing
capital-intensive
_The *size* of a long-term incentive award_ is based on _______ and _______ relationships. A long-term incentive award is governed by the rule of externally competitive and internally equitable. A stock option looks at different ways at valuing competitively and then develops an internal structure. The same is true with other long-term incentive plans. First, determine how much of the executive’s pay should consist of long-term incentives versus salary and annual incentives. Next, determine the proportion of each incentive plan to total long-term compensation.
The simplest way to determine the appropriate size of long-term incentives is to create a ______ or chart of current compensation levels in a _____ group of companies. From this data, select a target for a company’s chief executive officer. Next, determine a target for the lowest eligible level that is appropriate but does not signi cantly disrupt the pay curve relative to the level one below. This should ensure a relatively seamless transition into long-term incentive eligibility.
Once a plan is designed, it may require a _______ period to get it up and running. This usually requires an additional short-term plan. A few good candidates are performance share, performance unit or similar plans. Since the regular plan makes no payment until after the end of the performance period, no payment will be received for the first three to five years. The phase-in plan must address the issue of no payments during this interim.
marketplace
internal
survey
peer
phase-in
grant frequency
The most common practice in both stock options and performance share/unit plans is an ______ grant. This dollar averages the highs and lows of the stock price. An added advantage of annual grants is the resulting _____. With a four-year performance share plan, there are four unvested plans at work. With a ten-year stock option, there are ten years of options outstanding at any time. This annual overlap is a positive factor in ________.
A calculation to determine the annualized number of shares for companies that do not grant annually is to divide the total number of shares used over a period of time by the number of years. This is referred to as the average annual ______ total. When it is divided by the total shares outstanding, the resulting number is the average annual _____.
- annual
- overlap
- retaining executives
- run
- run rate
*
Stock options are typically _______ vested at the rate of 20% to 25% a year. Some use the all-or-nothing cliff vest. For example, a stock option with a four-year cliff-vesting schedule would not be 100% vested until the end of the fourth year. Zero would be vested prior to the end of the fourth year. Some grants are not exercisable until certain price or performance requirements have been met.
An interesting question is what, if anything, to do in cases of death, disability, retirement or change of control. Most plans provide some form of liberalized vesting. Many plans make the nonvested option exercisable for a stated period of time. The same would also be true for a restricted stock award. Other possible actions are full payment for the period, ______ in a discretionary manner or complete _____.
installment
prorating
forfeiture
Given the type of long-term incentive plans and the number of eligible candidates and possible award sizes, one can estimate how many shares will be needed. Typically, plans span a ten-year period and must receive shareholder approval.
Historically, shareholders deemed appropriate a ______ percentage of outstanding shares each year for executive stock plans. For years, many institutions used the five-and-ten formula in deciding whether to vote in favor of a stock-plan proposal. The idea was that a request for anything up to 5% was reasonable, between 5% and 10% might be reasonable and anything above 10% was unreasonable. Start-up companies, high-technology organizations and those with broad-based stock option plans going well down into the organization will require ____ numbers.
Dilution is always a shareholder concern. An increase in the number of shares outstanding dilutes _______ and may therefore impact stock price. A more appropriate way to measure dilution may be to assume the option price and the tax value of the deduction if any is used to _______ shares on the market. In this way, only the incremental number of shares dilute outstanding shares. Some companies do this, as there is no associated expense. However, the company does lose the positive cash flow of the option proceeds and tax deductions.
stated
higher
earnings per share
repurchase
A formal stock plan consists of two slightly different documents. The
first is a document typically prepared for stockholder approval and referred to as the ______ plan or the shareholder plan. It authorizes management to use company stock as a form of compensation within the limits prescribed by the plan. Various overseers may mandate such a document.
The second document is created for the executive and is referred to as the _______ plan. The document is typically approved by the compensation committee of the board and specifies the terms and conditions of the stock award/option. Each is a formal contract. One is with the shareholders and the other is with the executive.
The formal plan will typically state its purpose as being to effectively attract, retain and compensate ________ to ensure company success and provide a reasonable return on shareholder investment. The executive plan may repeat this and go further. If it includes a stock option, the letter will indicate the opportunity to share in the future growth of the stock price. If it includes a time-based stock award, the letter will talk of the value of providing future pay. If it includes a performance-based stock award, the nature of such performance will be described. Both documents identify and describe _______ used in each plan.
formal
executive
key employees
key words
What is stock ownership?
Many companies expect their top executives to _______ the stock that they have acquired through stock options and stock awards. Their expectations may even be requirements of the position.
Stock options should not be confused with stock _____. The first is an opportunity to acquire stock at favorable prices, but if cashed out, there is no increase in stock ownership. This does not mean, however, that those holding options are not interested in stock price. They are as long as they hold the option. _______ are also more likely to motivate than stock awards because they are leveraged and have less downside risk.
The downside of stock ownership guidelines is that once implemented, they de facto endorse _______ of the executive’s portfolio unless stated as minimums and periodically increased. Some argue for a range of ownership with an aggressive high-end number.
hold on to
ownership
Stock options
diversification
Who is affected by stock ownership, and how are guidelines for stock ownership determined?
Guidelines are directed at those executives with the strongest ______ on stock price. For that reason, they usually apply to the CEO and other very senior executives. When ownership guidelines go further down in the organization, the objective is to create a closer connection between the individual assets and company stock performance.
The guideline is typically expressed as a multiple of ____. However, some choose to specify a number of shares or a percentage of a transaction. When pay is the basis, the multiple may be assigned to job grade, organizational level or pay directly. Regardless of the basis, this method is called the ________.
influence
pay
multiple approach
The multiple approach is a multiplier applied to pay, such as three or four, and the product divided by the price of the stock. Some companies will include bonuses with salary to determine the multiple. If a bonus is included with salary, one would expect a ______ multiple. For example, a multiple of eight could be used with salary only and a four or five would be used with salary plus bonuses included. Since salary is much more constant than total pay, movements in stock price are more likely to have a more negative impact on a salary-only formula. This is based on the supposition that bonus may vary more in line with stock price than salary. Ownership targets are often highest for the CEO who has held the position longest. Not only are they increased from time to time, they may also depend on time in position.
Instead of the multiple approach, a company could use a set number of shares. Using a set number of shares has the advantage of _______ the executive in times of rising or falling stock prices, which is not true of the multiple approach. Falling stock prices would force the executive to buy and hold more stock, which could cause a significant financing problem. Needless to say, guidelines will be sorely tested in a long-term _____ market. Expressing the guidelines as a percentage of the last three or more years of options granted might minimize the impact of sharp increases or decreases in stock price. When and how much to adjust the number of _____ is a major problem with this type of approach.
lower
cushioning
bear
shares
Who is affected by stock ownership, and how are guidelines for stock ownership determined?
Ownership objectives can be met in one of three ways. These are encouraged by the company, rewarded through plan design and/or mandated by the company.
- The first is one of the objective by ______. Typically, the CEO takes an aggressive personal ownership in company stock and asks other senior executives to join in.
- The second is through a number of stock plan _____ described earlier including option reloads, additional share awards for exercised options held for a stated period, share deposit options, cancellation of nonrecourse loans and other devices.
- The third is more straightforward. Individuals are given a number of _____ to attain the stated number of shares. Barring unusual circumstances, the person may be denied new options until the requirement is met.
leadership
features
years
Plans that do not permit their recipients to own publicly traded or privately held stock are called _____ plans because the stock does not really exist. such plans may also be called shadow or pretend stock plans. there are two types of such plans. these are ______-based and ________-based plans.
phantom
market value
nonmarket value
market value-based stock plans are a form of _______ pay that uses company stock as the basis for measurement. there are three types, which are
- ______ equivalents
- ______ rights and
- ______ units.
Payments are in cash.
incentive
- dividend
- appreciation
- full-value
