Plan Complexity
The terms and conditions of equity programs are often the key driver of complexity – before the size of the plan, jurisdictions in which awards are granted, and internal reporting protocols. Compensation committees and human resources executives are becoming increasingly creative in the awards they design, which translates into a variety of reporting challenges.
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As the first-to-market with solutions for performance-based awards, we are continuously amazed by how each award structure is differentiated and unique. Our reporting solutions are customized to fit each plan so that all plan criteria are appropriately handled. We do not take a “check-the-box” approach that assumes all performance awards are the same.
As you consider the complexity of your equity award programs, some of the following questions and topics may resonate:
Do you grant or intend to grant awards containing performance conditions?
- On top of the variable accounting imposed by such award designs are a host of additional nuances firms often struggle with:
- Multi-tranche awards containing multiple grant dates – not only do these types of awards introduce a tiered (decelerated) amortization schedule, they also require multiple valuations at different points in time.
- Performance provisions not being stipulated at grant resulting in delayed grant dates or a service inception date preceding the grant date
- Performance period starting and ending dates not being aligned with requisite service period starting and ending dates
- Interaction between retirement eligibility conditions and performance provisions
- Interaction between qualifying termination provisions and performance provisions
- Determining contingently issuable shares for purposes of computing Diluted EPS.
Do you grant or intend to grant awards containing market conditions?
- Market-based awards are mostly challenging from a valuation
perspective, however, they pose a variety of reporting requirements:
- Multi-tranche awards containing multiple grant dates – not only do these introduce a tiered (decelerated) amortization schedule, they also require multiple valuations at different points in time.
- Interaction between retirement eligibility conditions and qualifying termination provisions in relation to performance provisions.
- Determining contingently issuable shares for purposes of computing Diluted EPS
- Computing unrecognized compensation cost and the excess tax benefit in the Diluted EPS calculation – considerable controversy among auditors as to whether these calculations should use the grant-date fair value (effected by the market condition) or EPS-specific multiplier (adjusted each period based on progress toward the market condition).
Do you grant or intend to grant awards containing both a market condition and performance condition?
- In addition to the issues facing performance-based or market-based awards on a standalone basis, hybrid awards introduce a variety of additional challenges:
- Independent conditions where the market condition and performance condition do not affect each other. This requires bifurcating the award so as to account for each condition separately and using the correct accounting model for that condition.
- Interdependent conditions where the outcome on one condition modifies that on the other condition. This requires estimation of a unit fair value that is effected by the market condition, and then adjusted each period based on the expected performance condition outcome.
Do you grant or intend to grant liability awards?
- The measurement date on a liability award is the settlement date, which means the fair value is re-measured each period until settlement.
- This gives rise to a variable accounting model in which expense (and the corresponding deferred tax asset) is continuously updated on a cumulative effect basis each period.
- The result can be significant P&L volatility, as well as volatility in the deferred tax asset (although there will never be an excess benefit or deficiency at settlement).
Do you grant or intend to grant non-employee awards?
- Unlike liability awards, the measurement date for non-employee awards is the vesting date, which is typically prior to the settlement date.
- As a result, these awards face the same valuation issues as liability awards, as well as an additional complication in the deferred tax accounting since the cumulative DTA will likely not equal the actual tax deduction (giving rise to an excess benefit or deficiency).
Do your awards contain retirement eligibility conditions?
- Plain vanilla retirement eligibility provisions serve to truncate the stated service period, thus accelerating the period over which expense is recognized.
- Many firms, however, have different retirement eligibility rules for different plans – this creates challenges in mapping the correct provisions to individual grants.
- Some firms also have partial retirement eligibility provisions that accelerate only a pro rata portion of the award – these can be very mathematically complex to correctly factor into the amortization model.
Do your awards contain clawback provisions or do you intend to implement such provisions?
- Clawback provisions are extremely new to equity compensation, and at this stage no two look the same. The onset of Dodd-Frank is bound to substantially change the structure of clawback provisions, both increasing their prevalence and their teeth. Clawback provisions can affect the requisite service period and even push out the grant date on an award.
Do you grant non-forfeitable dividends that are classified as participating securities?
- The dividends must be accounted for using the two-class method and not within the standard diluted EPS framework.
Equity Methods is responsible for accounting for some of the most complex equity plans in existence, including a 21,000-participant, dual performance and market award plan; public private equity firm with partnership accounting requirements, and hundreds of others. Equity Methods’ experience in supporting complicated equity award plans is second to none.
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