Creative employee compensation
by William G. Lako, Jr.
June 06, 2013 11:38 PM | 2378 views | 1 1 comments | 76 76 recommendations | email to a friend | print
William G. Lako Jr.<br>Business Columnist
William G. Lako Jr.
Business Columnist
Companies often look for creative ways to compensate their employees. Most personnel are familiar with a bonus check, holiday gift cards or perhaps a company-paid trip. Another way companies reward key management employees or highly compensated employees is through equity-based compensation. One mutually beneficial equity-based compensation program is restricted stock.

In a restricted stock program, employees are compensated with a number of shares of company stock subject to certain restrictions. Stock is usually nontransferable and subject to forfeiture under certain conditions. A company may require the employee remain with the company for a certain number of years before the shares are completely vested, or the vesting schedule may be tied to company or employee performance. Generally, with publically traded companies, employees do not pay for the restricted shares when they are granted. Regardless of how the company’s stock price fluctuates, the benefit almost always carries a monetary value when it vests.

Let me illustrate with an example: You receive a promotion to a high-profile position in your company. As part of your compensation package, you are awarded 15,000 shares of company stock with a vesting schedule over the next five years. After the first year in your position, 1,000 shares vest, meaning you will have full ownership of 1,000 shares. At your second anniversary, 2,000 shares will vest, and so on until your fifth year, when your remaining 5,000 shares vest. However, if you leave the company before the third year in your position, you forfeit 12,000 shares of unvested stock. Sometimes restricted stock is awarded each year. Therefore, if you leave the company, you leave some compensation on the table.

Restricted stock plans differ from stock options in that a stock option is only of value if the fair market value of the company’s stock is greater than the exercise price. For example, your company’s stock is selling today for $50 per share. Your company offers you the option to purchase 1,000 shares at that price with a one-year vesting period. In one year, you have the right to exercise your option to purchase the shares at $50 each. However, your option is only of value if the company’s stock price has increased to more than $50. With our restricted stock example, after one year, your 1,000 shares are worth their fair market value the day they are fully vested. Thus, a restricted stock plan may be the more coveted benefit. An equivalent number of restricted stock shares is almost always worth more than an option.

A restricted stock program is beneficial to the company in several ways. First, it reduces the cash compensation the employer pays out, therefore helping the company’s current cash flow. Second, it serves as an incentive to the employee, as a result of the vesting schedule. Third, restricted stock shares generally come with voting rights during the vesting period. Thus key employees should have a voice in decisions that shape the future of the company. Restricted stock also offers employees tax-deferred compensation as the shares are not taxed when granted unless otherwise elected. However, like most tax subjects, tax on restricted stock can be complicated, so I will cover that next week.

William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.
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John Olagues
June 07, 2013
The problems with regular restricted stock are:

1. The grantee gets a substantial benefit even when the stock does not appreciated in value.

2. On the vesting day, the grantee incurs a tax liability. Therefore generally all the stock is sold, there by eliminating all grantee/company alliance.

3. Traditional Employee Stock Options incur no tax liability upon vesting. Therefore the need for an immediate sale is not forced upon the grantee and grantee/company is longer. This makes the alignment longer. However, if the grantee wants to reduce risk after vesting of TESOs that are substantially in-the-money, the only efficient way of doing so is to sell exchange traded calls calls and buy puts.

Early exercise, sell stock and "diversify" is rarely an efficient strategy because of the two substantial penalties of forfeiture of the remaining "time value" back to the company and the incurring an immediate tax penalty. This early exercise strategy essentially benefits the company at the expense of the grantee.

So ESOs should be the preferred way of equity compensation, if the objective is to align interests longer and generate greater cash flows to the company. Grantees of ESOs can cash in only when the stock is higher than the exercise price.

The problem is that traditional ESOs make it difficult to manage the risks of holding vested substantially in-the-money ESOs, especially when selling calls is discouraged or prohibited.

To correct the biggest drawback of ESOs, whereby the remaining "time value" is forfeited upon exercise of Traditional ESOs, the options contract can be altered to make the otherwise forfeited remaining "time value" returnable to the ESOs holder in the form of new ESOs..

See for full explantion


John Olagues
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