Benefits and beyond c. 11 equity

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Benefits and beyond c. 11 equity

  1. 1. Benefits and Beyond, C. 11<br />Equity Benefits<br />Thomas E. Murphy<br />1<br />Thomas E. Murphy<br />30 November 2010<br />
  2. 2. You own the company!<br />2<br />Thomas E. Murphy<br />30 November 2010<br />
  3. 3. Our employees own the company. (Avis Car Rental)<br />Could this be the ultimate link among leaders, employees, and owners?<br />Focused application of the Agency Theory<br />Aligning Total Shareholder Return between traditional and employee shareholders<br />New strategy: “attitude of ownership.” <br />Background<br />3<br />Thomas E. Murphy<br />30 November 2010<br />
  4. 4. What’s the down side?<br />But . . . . <br />It can be powerful<br />Line of Sight<br />Dilution<br />Stock needs large public ownership to exploit market dynamics.<br />During market slides, it could have reverse effect on employees.<br />Thomas E. Murphy<br />4<br />30 November 2010<br />
  5. 5. Thomas E. Murphy<br />5<br />Lyle Everingham – in W. Virginia<br />30 November 2010<br />
  6. 6. 401(k) included company stock. Matches are often made in company stock<br />Kroger grew in employee ownership from 1% to 33% in 3 years with its 401(k). <br />Profit Sharing Retirement Plans included company stock and provided good accumulation of wealth. (P&G)<br />ESOPs are totally company stock based.<br />Retirement Plans and Stock<br />6<br />Thomas E. Murphy<br />30 November 2010<br />
  7. 7. Discount Stock Purchase Plans (with “DRIPS.”) <br />Brokerage fee free stock purchase plans<br />Stock option plans<br />Restricted stock and Restricted Stock Units<br />Stock Appreciation Rights (SARs)<br />All of these can lead to substantial wealth accumulation<br />Other Plans – A U.S. Culture<br />7<br />Thomas E. Murphy<br />30 November 2010<br />
  8. 8. Alignment!<br />8<br />Thomas E. Murphy<br />30 November 2010<br />
  9. 9. U.S. companies prefer variable compensation plans.<br />U.S. companies want “balance” in their rewards: short term (cash); mid-term (annual bonus); long term (stock and stock options) <br />Equity can provide an opportunity to pay less than the market in cash compensation.<br />Equity can be a factor in recruitment and retention.<br />Rationale<br />9<br />Thomas E. Murphy<br />30 November 2010<br />
  10. 10. Thomas E. Murphy<br />10<br />Balance – short, medium and long term reward plan<br />30 November 2010<br />
  11. 11. Equity can provide an opportunity for a new level of employee communication.<br />Equity should not be reserved for “executives only.” <br />More companies have gravitated toward broad based stock, restricted stock, and options plans. <br />What about the “global” use of equity? The U.K. is an exception, but inhospitable tax and policy treatment in EU. <br />Rationale<br />11<br />Thomas E. Murphy<br />30 November 2010<br />
  12. 12. What are they?<br />12<br />Thomas E. Murphy<br />30 November 2010<br />
  13. 13. Grantee can buy stock at market price on date of grant (the “strike price.”)<br />Options can be exercised when vested.<br />Vesting can be graduated or cliff.<br />Vested options can be exercised over their term, which is usually 10 years.<br />Options are often granted annually. <br />The “option spread” is taxable (ordinary income) to the grantee when exercised.<br />What is a Stock Option<br />13<br />Thomas E. Murphy<br />30 November 2010<br />
  14. 14. 30 November 2010<br />Thomas E. Murphy<br />14<br />The “strike price and the spread”<br />
  15. 15. Incentive Stock Options (ISOs) are not taxed until the recipient sells the exercised stock. <br />NQSOs are taxed on exercise. <br />Typical exercise: see page 337.<br />What is a stock swap: see page 338.<br />What is a “cashless exercise?” Why would a company offer these? See page 338.<br />Stock Options – Mostly NQSOs<br />15<br />Thomas E. Murphy<br />30 November 2010<br />
  16. 16. As compared to shareholder? No money down.<br />If stock price goes down, no actual loss to Optionee.<br />Except lower total reward<br />Employer’s costs<br />Thomas E. Murphy<br />16<br />Allocation of Risks – Big Jump?<br />30 November 2010<br />
  17. 17. 30 November 2010<br />Thomas E. Murphy<br />17<br />Options require large grants!<br />
  18. 18. Options are compensation; therefore, they should be taxed as income. But, when and at what value?<br />When there is a spread?<br />When they are exercised?<br />When they are granted?<br />Note the cost of dilution: cents per share (at page 340 of the text).<br />What about the discount value of options as a method to value? (The time value of money) <br />Costing Options<br />18<br />Thomas E. Murphy<br />30 November 2010<br />
  19. 19. FASB and No. 123R. Must be charged “their fair value” at grant.<br />One method is the Black Scholes formula which considers term of grant, grant price, volatility of price, and other factors to estimate their value at grant.<br />This represents new expense for companies, and caused some employers to re-think offering options. The charge against earnings could be significant. <br />Cost of Options<br />19<br />Thomas E. Murphy<br />30 November 2010<br />
  20. 20. What happens when the market price of the stock is below the strike price? <br />“underwateroptions”<br />Is the notion of an “ownership society” in trouble due to the bear market of 2008 and 2009?<br />Thomas E. Murphy<br />20<br />Deep Thoughts . . . <br />30 November 2010<br />
  21. 21. 30 November 2010<br />Thomas E. Murphy<br />21<br />Restricted Stock – less costly?<br />
  22. 22. No stock is actually issued. <br />No dividends and no voting rights are available, except in some cases the employer can pay a cash equivalent of the dividend. <br />They are an unfunded promise to issue a specific number of shares when the restrictions lapse. <br />Taxed upon vesting. Withholding can occur by simply reducing the number of shares delivered. <br />30 November 2010<br />Thomas E. Murphy<br />22<br />What are RSUs? Same as RS except:<br />
  23. 23. RS and RSUs provide added advantages<br />There is less dilution?<br />Granted in similar fashion.<br />For RS, grantee can make an §83b election.<br />Charge to earnings at grant – but known value.<br />Query: do restricted stock grants represent lower risks to employees? (See page 342)<br />RS and RSUs<br />23<br />Thomas E. Murphy<br />30 November 2010<br />
  24. 24. What are Stock Appreciation Rights?<br />What are their design features?<br />What about dilution?<br />What are the risks?<br />How are they expensed and taxed?<br />How are they “paid off?”<br />See illustration at page 343<br />Other Equity Grants<br />24<br />Thomas E. Murphy<br />30 November 2010<br />
  25. 25. Do they affect behavior?<br />25<br />Thomas E. Murphy<br />30 November 2010<br />
  26. 26. Do they really motivate and change behavior?<br />How are they abused? Mega grants and back dating.<br />How significant is the dilution problem? <br />Line of Sight and “Pepsi Share Power.”<br />What are the employer’s choices if the options granted are “underwater?”<br />Some Problems with Equity<br />26<br />Thomas E. Murphy<br />30 November 2010<br />
  27. 27. Maintain the grant and hope for an increase in price.<br />Option holders turn in their options and are given a “scrap value.”<br />Options are turned in and new ones are issued in their place at the lower, current market price. (or exchanged for RSUs)<br />Options are simply re-priced with a lower strike price, or are “backdated.”<br />Thomas E. Murphy<br />27<br />The Choices for Underwater<br />30 November 2010<br />
  28. 28. Do they get any of these opportunities?<br />How do you think they react to the choices in the previous slide?<br />So, what is another approach to equity that might really affect behavior and satisfy the interests of shareholders?<br />Thomas E. Murphy<br />28<br />What about shareholders?<br />30 November 2010<br />
  29. 29. Thomas E. Murphy<br />29<br />A different trigger – performance based vesting!<br />30 November 2010<br />
  30. 30. Link vesting to the attainment of certain performance standards.<br />What standards? <br />Total Shareholder return? Earnings per share? Profits? Sales increases? EBITDA targets? Market share improvements? Indexed stock price increases, unit performance, department performance, individual performance? <br />Performance Based Equity<br />30<br />Thomas E. Murphy<br />30 November 2010<br />
  31. 31. There is an issue concerning the accounting treatment of performance based equity?<br />How are they charged to the financial statements?<br />What impact does it have on the previous stated “abuses?”<br />How do they work? See example at page 349. <br />Performance Based Equity<br />31<br />Thomas E. Murphy<br />30 November 2010<br />
  32. 32. Does employee ownership cause them to “think like owners?”<br />What should be the elements of a “culture of ownership?” <br />How would you design and evaluate such a program?<br />See: Van Meter Co. at page 351. Effectively communicating the things within their line of sight that affect the stock price. <br />Thomas E. Murphy<br />32<br />Does it work?<br />30 November 2010<br />
  33. 33. Thomas E. Murphy<br />33<br />The concomitant opportunity<br />30 November 2010<br />
  34. 34. Example: 1000 Shares of SARs at $10/share; they are vested, and new price is $25 per share. How many shares do you get? (25,000-10,000 = 15,000/25 = 600 shares. Taxed as ordinary income with FICA and Medicare payroll taxes. <br />Some cites and exercises<br />34<br />Thomas E. Murphy<br />30 November 2010<br />
  35. 35. Go to www.mystockoptions.com/“quick take calculator”)<br />10,000 shares of NQSOs, $10 strike price, $22 current price. All are vested and exercised. What is gain? How will it be taxed and when? <br />Exercises and cites<br />35<br />Thomas E. Murphy<br />30 November 2010<br />
  36. 36. You work for a call center company that performs HR and Benefit services for a number of large employers. Your company has 10 call centers in the U.S. with about 200 employees in each. Your CEO wants you to study and recommend a possible broad-based equity benefit. What are the issues, analytical steps you would take, the potential design choices and “returns.” What would you recommend?<br />Thomas E. Murphy<br />36<br />Does Equity Compensation Work?<br />30 November 2010<br />
  37. 37. Exercises at pages 352-353<br />Practice. . . . <br />More practice . . . <br />1. Spinoff at Call Center. Equity for employees?<br />2. An exercise of partially vested SARs.<br />3. Option exercise of partially vested shares. Why exercise with only a 50 cent increase?<br />4. Performance based options based on individual performance. Problems?<br />5. Options for European employees of U.S. company. <br />Thomas E. Murphy<br />37<br />30 November 2010<br />
  38. 38. Pay lower fixed compensation.<br />Communicate with employees on a higher level.<br />Opportunity to engage employees in the affairs of the business<br />Thomas E. Murphy<br />38<br />The Power Potential of Equity to Create Team-Based Alignment!<br />30 November 2010<br />

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