9 - Long-term incentives—Part II Flashcards
summarize the history of statutory stock options
The first stock option form receiving favorable tax treatment was the restricted option as defined in Section ____ of the Internal Revenue Code (IRC). The Revenue Act of 1964 terminated the restricted form of option and introduced a new form of statutory option—the qualified option. Like the restricted option, the qualified option imposed no tax liability on the holder either at time of grant or time of exercise. Thus, while the qualified option was not as attractive as its predecessor, it was still more palatable than anything else, given (a) a rather favorable growth in ______ and (b) marginal tax rates as high as ___% before the 1964 Revenue Act.
The 1969 Tax Reform Act took three further swings at the attractiveness of the qualified option.
First, it lowered the maximum marginal tax rate from 70% to ___% on earned income.
Second, the long-term capital gains tax maximum of 25% was increased to one-half the ordinary income tax rate except for the first $_________, which was still subject to a 25% rate.
Third, it introduced a new form of tax called an alternative minimum tax (AMT), that would apply to certain items. This tax preference income (TPI) would be taxed at the rate of 10% above a $30,000 exclusion.
The 1978 Revenue Act reduced the portion of long-term gains subject to taxes from half to 40%, thus effectively lowering the maximum capital gains tax rate from 35% to 28%. In addition, the untaxed portion of capital gains income was no longer subject to the 15% _____ tax.
- 424
- stock prices
- 77%
- 50%
- 50,000
- preference
Each of these legislated changes made nonqualified stock options comparatively more ______. The 1981 Economic Recovery Tax Act restored statutory stock options, now called the ______, with the following requirements:
(a) The plan must specify the employees or class eligible, the number of shares available for grant and be approved by shareholders within 12 months of the date the plan is adopted.
(b) Grants under the plan may not be later than ___ years from adoption or approval date of the plan.
(c) The grant price may not be less than the fair market value on the date of grant.
(d) The exercise period generally may not exceed ten years from the date of grant.
(e) The value of the grant may not exceed $_______ per person with limited carryover to subsequent years.
(f) The optionee must be an employee and exercise the option not later than _____ months after leaving employment, one year for disability or to term for death.
(g) The option is not _______ by the optionee other than by will or the laws of descent and distribution and is exercisable only by the optionee during his or her lifetime.
(h) The optionee incurs no ordinary income upon grant or exercise of an ISO but may be subject to ____.
(i) The optionee may not sell the acquired shares sooner than two years from the date of grant or within one year after exercise.
(j) ISOs are not subject to _______ requirements.
The 1997 Taxpayer Relief Act lowered the long-term capital gains rate to ___% for those assets held 18 months or longer, while retaining a ___% rate for those held more than 12 months but less than 18 months. A year later, the 20% applied to assets held more than 12 months
attractive
incentive stock option (ISO)
ten
$100,000
three
transferable
AMT
discrimination
20%
28%
______. this is a stock option that fails to meet the requirements of a statutory option and therefore is more flexible in terms of grant size, ability to exercise, length of grant and holding period. As with a statutory option, there is no tax liability at time of grant. However, at time of exercise, the spread between market value and option price is taxed income. Since it is taxed as income, the ___ does not apply at time of exercise although the gain at time of sale will be subject to the alternative minimum tax without adverse maximum tax consequences. The holding period to achieve long-term capital gains is the same as for other holdings.
The most common form of nonstatutory options is a nondiscounted, ten-year grant, probably due to a carryover of the former Securities and Exchange Commission (SEC) rules that an option for insiders could neither be discounted nor exceed ten years in duration in order to be an exempt transaction at time of grant.
nonstatutory stock option
TPI
The most common form of nonstatutory options is a ______, ___-year grant, probably due to a carryover of the former Securities and Exchange Commission (SEC) rules that an option for insiders could neither be discounted nor exceed ten years in duration in order to be an ______ transaction at time of grant.
nondiscounted
ten
exempt
For years, stock options have been one of the more acceptable forms of incentive compensation to shareholders because:
- (a) The executive must put up some of his or her own _____.
- (b) The value, like the shareholders’, is at risk with the price of the ______.
- (c) Assuming no discount, there is no charge to ________.
Options are a form of _______ that link the professional manager’s financial success to that of the shareholder.
For those who are about to make an initial public offering (IPO), moving the company from a privately held to a publicly traded company, there is a high degree of interest in large stock option grants. Historically, stock prices ______ dramatically in the days and weeks preceding an IPO.
- money
- company stock
- corporate earnings
profit sharing
increase
The ______ is another feature many companies used in conjunction with a nonstatutory option. This permits the optionee to receive the appreciation of fair market value over option price in stock and/or cash without providing funds to pay the option price.
stock appreciation right
Stock appreciation rights may be granted in parallel, in tandem or on top of a stock option.
A tandem grant would mean the exercise of one would proportionately ______ the other.
A parallel grant would mean the two are _______ of each other.
Under an additive grant, for example, the exercise of 4,000 options would automatically result in the additional payment of 4,000 stock appreciation rights.
A limited stock appreciation right is one that is in effect only under specified circumstances.
Stock appreciation rights can also be freestanding, namely, not connected in any way to a stock option. Self-standing, or freestanding, stock appreciation rights are really ______ awards, since there is no accompanying stock option. Such a plan must be designed carefully to avoid an IRS ruling of constructive receipt due to lack of alternative right. An important point to remember in structuring a plan to avoid constructive receipt is the basic principle that if income is available only if the individual forfeits a valuable right, then income is subject to a _________ and not constructively received.
reduce
independent
phantom
substantial limitation
The stock appreciation right is typically attached to the stock option at time of grant. If granted later, the fair-value expense charge would be determined at date of grant.
Financial Accounting Standards Board (FASB) Interpretation Number 31 requires that when stock or cash is available under payout, it will be assumed to be _____ unless there is a reasonable basis for assuming otherwise. A resolution by the compensation committee to make stock appreciation rights settlements in cash would presumably meet this reasonable basis. If the executive had a choice, it would probably be necessary to assume a stock settlement. However, if the executive decided to exercise the stock option rather than take the stock appreciation right, the accruals established as a charge to earnings logically would be eliminated since the stock appreciation right liability has been removed.
stock
Discuss the exercise period with regard to a stock appreciation right.
The most common approach during the exercise period is to make the stock appreciation right exercisable at the same time as the underlying ______. Some plans allow recipients to exercise stock appreciation rights only within prescribed periods each year. Such periods may be limited, such as ten days following ________ statements, and may apply to 16(b) executives and others, for stock as well as cash settlements.
In addition, companies need to decide whether or not to keep the stock appreciation rights open after death or other termination. If so, they may want to limit the number of shares available on date of termination or available at time of exercise, whichever is less.
stock option
quarterly earnings
Why use stock appreciation rights?
Stock appreciation rights are most attractive in times of _______ and low _______ and were created at a time when insiders had to wait six months after exercising an option before they could sell the acquired stock. The popularity of stock appreciation rights waned with the spread of stock for stock and cashless exercise of stock options, since the executive ended up with the same number of shares or cash equivalent that would have been received through exercise of the stock appreciation rights. While all three transactions bring a tax deduction to the company, the stock appreciation right resulted in a charge to corporate earnings, whereas the stock-for-stock exchange and cashless exercise did not. But stock appreciation rights became more popular when FAS 123R put them and stock options on equal terms for a charge to the earnings statement. They are also used in two unique situations. The first is when the country in which the optionee resides imposes _____ and/or prohibits holding the security of a foreign country or perhaps using foreign currency to purchase those shares. The second situation is when there is a change of ______ of the company. A typical clause would be the 100% vesting and automatic payout of the stock option appreciation in the form of stock appreciation rights.
high-interest rates
stock price appreciation
onerous taxes
control
While stock options promote ownership among key employees, excessive use will ______ shareholder equity. An alternative form of promoting ownership is the executive _______ plan. the key difference between the two is that the latter has a much more limited period in which executives may decide whether or not to buy the stock. While the stock option may be up to ten years, the purchase plan typically allows a month or two
dilute
stock purchase
Briefiy explain fixed cost and variable basis for payment combination of an executive stock purchase plan
Given an amortization schedule to retire a loan, a company may establish a formula indicating the portion of annual payment that may be ______ by corporate performance. These loan forgiveness amounts are charged to company earnings, reported as income to the executive and taken as a company tax deduction. Remember the 2002 Sarbanes-Oxley Act prohibits company _____ to executives and directors.
canceled
loans
Briefly describe a variable cost and flxed basis for payment combination of an executive stock purchase plan.
Rather than set purchase price at the time of purchase, it is possible to determine in advance the cost of the shares to be purchased that year. The amount of annual _______ is taken as a charge to company earnings, reported as income to the executive and identified as a company tax deduction. Alternatively, or on the assumption that the price should really be a function of earnings, the formula could use some multiple assigned to earnings per share.
discount
the variable cost and variable basis for payment is simply a combination of two variable formulas, one determining the ____ and the other determining the extent of ______. By definition, it is not only the most complicated combination, but also the most subject to dramatic ______ in the amount of value delivered to the executive.
cost
forgiveness
swings
A _______ is a stock purchase with a 100% discount. It can either be given immediately or restricted, with ownership deferred to a future date. Some companies choose to use ______ rather than stock awards. A _____ is the right to receive a share of company stock at a specified time in the future.
Awards that are paid immediately can be in recognition of a special accomplishment, a feature of the annual incentive plan or part of a package designed to attract an executive to the company. If the award is deferred to a future date, this decision could be by individual choice or plan design.
stock award
stock units
stock unit
