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Advanced Topics in Equity Compensation Accounting
by Takis Makridis
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Format: Perfect-bound book, 308 pages
Edition: Third edition (January 2013)
Status: In stock
Chapter 1: Valuation Models
Chapter 2: Expected Term
Chapter 3: Volatility Estimation
Chapter 4: Making Sense of Forfeiture Rates
Chapter 5: Expense Recognition for Market and Performance Awards
Chapter 6: Underwater Option Exchanges: Baseline Theory and Implementation Approaches
Chapter 7: IFRS 2: Today and Tomorrow
Chapter 8: Design Features Driving the Fair Value of a Relative TSR Award
Chapter 9: Accounting for Assumed Awards Under ASC 805
From Chapter 4, "Making Sense of Forfeiture Rates"Although the Dynamic Model does not trigger more or less financial statement volatility, it does reduce the risk of bias or imprecision in how the amortization model is updated to incorporate new information on actual forfeitures. This is because it automates the process. So long as a company continues to believe its forfeiture rate is a reasonable steady-state expectation, it can leave the forfeiture rate unchanged in the model and feel comfortable that outlier events (too many or too few forfeitures) are being automatically managed within the amortization model.
Consider the two outlier situations introduced in the prior section: first, where the 8,000-unit award forfeits in Q2, and second, where only the 250-unit award forfeits during the first three quarters. Beginning with the first scenario, assume a monthly soft close of February (month 2) is being performed and the 8,000-unit award is forfeited on the first day of February. The amortization model would reverse expense recognized in January on the 8,000-unit award while recognizing more expense on all other awards than what was recognized on them in January (reflecting their higher probability of vesting). Then in March, the 8,000-unit award would be gone altogether from the calculations, and the 10% forfeiture rate would continue to be applied to all other surviving awards over the then-remaining vesting period.
From Chapter 8, "Design Features Driving the Fair Value of a Relative TSR Award"As table 8-1 illustrates, a performance unit may convert into more than one share, thus providing additional upside for performance exceeding that of the median S&P 500 company. Similarly, however, if performance dips below that of the median S&P 500 company, units convert into shares at a percentage below 100% of the target units granted. In addition, because the performance metric is relative TSR, common industry events (e.g., general bull or bear markets, supply shocks, etc.) are filtered out of the performance measurement calculation. Note, for example, how a company could achieve positive (negative) TSR but still pay out below (above) 100% based on its relative ranking against the comparison group.
From the very outset, one fundamental problem to hone in on is the flawed assumption that a relative TSR award should have a grant-date fair value at or below 100% of the stock price on the date of grant. This is a common expectation among finance and HR professionals, but it is typically not the case. The purpose of this chapter is to demystify various drivers and factors behind the valuation of a relative TSR award, ultimately helping to facilitate tighter collaboration between HR and accounting/finance professionals during the design phase.