An executive compensation plan is one that rewards the performance of employees in order to motivate them. The share based compensation plan consists of stock appreciation rights, stock awards, and stock options which build share-holders’ equity. The nature of the compensation plan for XYZ Company will have an impact on the earnings per share calculation. The company will use the stock-based compensation strategy in order to attract and retain the best talent. By structuring the compensation plan properly, the company will benefit from a perspective of financial accounting and a tax deduction.
Under the restricted stock-award plan, XYZ Company grants 5 million of its $1 per common share on 1st January, 2012. The shares were subject to forfeiture in case the employment is terminated within a period of 4 years. The current share price is $12. The total compensation that is allocated to expense over the period of 4 years is as follows: $60m/4(years) = $ 15m annually. The XYZ Company would not want to transfer the share directly to an employee without putting in some restrictions that tie the employee to the company in a certain period. In case stock grant is under restrictions, the bargain element should be incorporated in the income of the employee as the shares become vested. This could sound beneficial at first, but in the long run it is detrimental. In case the company is successful, the value of the stock rises and consequently, the sum for compensation will increase. For instance, it would increase to a figure above $15million that is stipulated in the above calculation. However, the company could use this plan to their advantage especially when the employee do not carry on an election as provided by the tax law section 83(b), that an employee can conduct an election to lock in compensation amount at the grant date (Chingos, 2002).
On the other hand, the company could use the non-qualified stock options. This strategy does not require meeting the stringent law of tax that is imposed on the qualified options. The main advantage of this plan is that employee gets a compensation income that is equal to the bargain element, and additionally the Company gets a deduction of tax of a similar amount. Similarly, the company could also opt to use the Incentive stock plan (option), with this strategy the employee is not taxed until he or she sells the stocks. Additionally, if certain holding requirements are observed, the employee will be eligible for a long term capital gains. Conversely, if the period for holding is met, the Company will not receive any tax deduction.
If the company’s employer would wish to reward employee on the performance of the stocks of the company without giving up the ownership of the corporation, the stock appreciation rights is the best plan. In this plan, the employee gets the right of acquiring cash that is equal to the appreciated value of the stock. Similarly, in this plan the employee is entitled to compensation income during a payment period and the employer gets a deduction in tax of a similar amount (Chingos, 2002).
Stock based compensation strategies are successful plans that attract retain the employees, while incorporating the rewards of the workers to the benefit and success of the company. When a company is structuring and utilizing the compensation plans, it should ensure that it is done properly, in order to attract a favorable financial accounting and tax treatment for both the employees and the employer. The key to success is to ensure that both the employee and the employers understand the rules and that they plan accordingly.
- Chingos, P. (2002). Paying for performance: A guide to the compensation plan management. New York: John Wiley & Sons Publishers.