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Equity Alternatives: Restricted Stock, Performance Awards, Phantom Stock, SARs, and More

Formerly titled Beyond Stock Options

(Print Version)

Thirteenth Edition

by Joseph S. Adams, Barbara Baksa, Daniel D. Coleman, Daniel Janich, David R. Johanson, Blair Jones, Kay Kemp, Scott Rodrick, Corey Rosen, Martin Staubus, Robin Struve, and Dan Walter

This is the print version, and shipping charges apply. It also is available in a digital version with no shipping charges.
$35.00 for NCEO members; $50.00 for nonmembers

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For many companies, stock options, ESPPs, or ESOPs are not the only stock plans to consider. Instead, restricted stock awards, restricted stock units, phantom stock, stock appreciation rights (SARs), performance awards, and/or direct stock purchases are an essential part of their compensation strategies. This book/CD combination (formerly titled Beyond Stock Options) is an essential toolkit for everyone who needs to research or implement such plans. The book includes eight chapters on what the plan alternatives are, how they work, how to combine them, and the legal and accounting issues they raise. The authors include leading authorities from law firms, Deloitte & Touche, NASPP, and the NCEO. The book also includes a CD with set of model plan documents, most of them annotated, prepared by law firms. The plan documents are included in word processing format so you can easily edit and use them.

In the 13th edition, chapters 1 through 7 have been revised and updated (as of late 2014) where needed. Chapter 8 did not require any changes. Additionally, every plan document included with the book was reviewed and then revised when necessary.

Publication Details

Format: Perfect-bound book, 316 pages
Includes CD
Edition: Thirteenth edition (March 2015)
Status: In stock


Basic Issues in Plan Design
Phantom Stock and Stock Appreciation Rights
Restricted Stock Awards, Units, and Purchases
Performance Award Plans
Direct Stock Purchases in Closely Held Companies
Accounting Issues
ESOPs, ESPPs, 401(k) Plans, and Stock Options: When the Old Standbys Still Make Sense
A Tiered Approach to Equity Design with Multiple Equity Compensation Vehicles
Appendix: Using the Model Plan Documents
About the Authors
About the NCEO

Plan Documents on the CD:
Omnibus Incentive Plan
Phantom Stock Grant Notice and Agreement
Stock Appreciation Rights Award (Cash-Settled)
Stock Appreciation Rights Award (Stock-Settled)
Restricted Stock Award and Agreement
Restricted Stock Unit Grant Notice and Agreement
Performance Unit Award and Agreement
Direct Stock Purchase Plan Agreement


From Chapter 1, "Basic Issues in Plan Design"

In closely held companies, owners may have plans or obligations to provide family members, partners, or investors with a specific percentage of the company, either for control or economic reasons. Or, in many cases, they may have a conviction that they cannot share more than a certain percentage of total ownership rights. In some closely held companies, there are venture capital investors who may place strict limits on how much equity value can be shared, in whatever form. They may also have minimum guidelines from these investors for how much ownership they want key employees, or even all employees, to have, either by corporate contribution or by employee purchase. Companies with significant debt may also want to check whether there are any loan covenants that would make it difficult or impossible to pay out employees for their equity awards during the term of the loan.

The most common approach to this problem is to set a fixed ceiling on how much ownership or equity value can be shared, such as 10% of the shares at any time or 5% of the equity value of the company (earned in shares or in cash) in any two-year period. Deciding in advance on a fixed percentage, however, is probably the least rational way to make a decision on this issue. First, companies that are growing often make the error of setting aside a certain percentage of stock ownership or equity value for employees and giving out most or even all of these shares to whoever is there early on. As the company grows, it then has only a small and shrinking pool of stock ownership or equity value to make available to new employees. The result is that a two-class system emerges of owners and those owning little or nothing, even among people doing the same jobs.

Another problem with the fixed percentage approach is that even if employment remains fairly stable, the job market can change. While departing employees may surrender their shares to the company to give out to new employees, the new employees may now expect more stock ownership or equity value than the company can make available. Similarly, company philosophy can change, calling for a greater emphasis on equity awards.

Finally, 10%, or any percentage, of one company is not the same as 10% of some other company. Giving employees 10% of a startup without a product or profits is a very different matter than 10% of an established, profitable corporation. Very few employees actually care what percentage of a company they own, individually or (even less) collectively. They care about what it is worth. Deciding on how much to share should be a function of what is needed to attract, retain, and motivate people over time, including the possibility of growth, while at the same time not scaring off investors or existing shareholders.

From Chapter 2, "Phantom Stock and Stock Appreciation Rights"

SAR grants and phantom stock awards are generally made to encourage employee retention, provide an incentive to grow shareholder value, or a combination of both.

If the employer's principal objective is to motivate the participants in the program to grow the value of the business, a SAR grant is typically more appropriate. The holder of a SAR award receives no benefit unless the underlying stock value appreciates. As a result, the holder has an incentive to improve financial performance with the expectation of growing the stock value. SAR grants are frequently made subject to a vesting schedule to encourage retention, as well as to provide an incentive to grow value. However, the vesting element of a SAR grant is successful as a retention tool only to the extent that the value of the underlying stock continues to appreciate. If the underlying stock declines in value from the date of grant so that the SARs have no value, the employee might be more willing to entertain an offer to go elsewhere because he or she forfeits no value upon departure. For example, assume an employer makes annual SAR grants with a graded five-year vesting schedule for each grant. Assume further that the underlying stock value appreciates each year during the first four years from $10 to $15, $20, $25, and then $30. If, at the end of five years, the underlying stock is valued at $40 per share, the employee would have a significant unvested build-up of the early awards. In this case, the annual SAR grants, with their five-year graded vesting schedules, become a valuable retention device. If, however, the underlying stock is more volatile and the value at the end of five years, based on the prior example, drops to $20, the retention value is more limited.

Phantom stock awards are more valuable if the objective is to promote employee retention. Phantom stock awards are typically subject to a vesting schedule for several reasons, not the least of which is to encourage retention. The vesting schedule may be designed with specific objectives in mind. If the employer's sole objective is retention, the forfeiture provisions may be based solely on the passage of time (e.g., a five-year cliff vesting schedule, meaning the award does not vest at all until the end of the fifth year, at which time it becomes 100% vested). In this case, for example, if 500 units of phantom stock are granted when the underlying stock is worth $100 per share, the initial value of the award is $50,000. Even if the value of the stock drops in half to $25 per share, the employee would forfeit significant value if he or she left the company during the five-year period before the units become fully vested. Forfeiture provisions may also be designed to assure that the employee remains in the service of the company during a critical period. For example, the vesting provisions may be tied to the repayment of the company's outstanding senior loan or until the completion of a merger or acquisition. In addition, if the objective is a combination of retention and performance, the size of the award or vesting provisions could be tied to the achievement of certain financial targets (e.g., EBITDA targets). For example, some plans use relatively long vesting schedules (e.g., six to seven years) for grants, but provide that vesting will accelerate if certain performance measures are satisfied. Alternatively, it would be possible to achieve a combined goal of retention and performance incentives by granting a target number of phantom shares and then adjusting the number of shares over a specified performance period.

Although it is a broad generalization, it would be more common to see top-level executives receiving SARs (because the executives would be perceived as making policy-type decisions more likely to affect the stock price), next-tier executives receiving a combination of SARs and phantom stock, and still lower-level executives receiving all phantom stock (to encourage retention).

From Chapter 4, "Performance Award Plans"

Occasionally a payout will be made on a goal that is later determined to have been missed. Plan design must include provisions for this possibility. Corrections may be due to accidental circumstances or some type of impropriety. Accidental circumstances may include miscalculations, data that was inadvertently missed at the time of vesting, or data that was initially included in totals but had to be rolled back for some reason. An example would be a large transaction that was included in revenue totals for given period and then subsequently fell through with the deal never resulting in income to the company. The most visible example of circumstances that are not considered accidental are those resulting in a restatement of financial statements called out specifically by Section 954 of the Dodd-Frank Act. This law requires companies with securities listed on a U.S. exchange to adopt a clawback policy applicable to executive officers in the event of an accounting restatement due to material noncompliance with financial reporting requirements.

It is critical that a plan clearly document the correction policies for all types of corrections. Many plans allow, but do not require, the company to demand repayment of funds associated with errors. In the event that the error is immaterial, most companies will not make a correction. Where an accidental mistake was material but due mainly to the timing of data collection or to a transaction that will be included in a future measurement, many companies will incorporate adjustments at later date. Policies regarding corrections to performance equity payouts are not yet, and probably will not be anytime soon, universal. The most important consideration is clear and unequivocal documentation of the company's approach to these types of errors.

Other common triggering events for clawbacks related to performance awards include an individual being terminated for "cause" or an individual violating restrictions clearly defined in the plan, agreement, or related employment agreement, such as a noncompete clause. Anything that may lead to a clawback should be clearly documented in advance. Attempting to correct a payout or have it returned is very difficult without unambiguous and agreed-upon language.