Long-Term Incentive Plans for ESOP Companies
An NCEO Issue Brief
by Paul Horn and Matt Keene
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Format: PDF, 26 pages
Dimensions: 8.5 x 11 inches
Edition: 1st (September 2012)
Status: Available for electronic delivery
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Basic LTIP Concepts
Taxation of Benefits
Special Considerations for S Corporations
Liquidity and Award Duration
Financing the Award Obligation
Non-Equity Incentive Plans
Deferred Cash Compensation
Long-Term Cash Incentive Plans
Stock Appreciation Rights (SARs)
This repurchase issue can become a problem for LTIP participants where they are taxed, for example, on the full amount of their option exercise and sale to the company, but the company can pay them only in part because of an annual liquidity limit or other cash flow constraints. Actual equity awards, such as restricted stock and stock options, can present a timing mismatch because the awards are generally taxed to the recipient when vested or exercised, even if the company does not have the cash to monetize the settlement of the award.
Due to these liquidity constraints and the other issues we have already discussed, most LTIPs for privately held ESOP companies are in the form of equity-based awards. The equity-based awards—namely phantom stock and SARS—are normally settled in cash, and the recipient's taxation generally matches the receipt of cash.
The "cost" of this liquidity can be significant, and this LTIP liability is in addition to the ESOP repurchase obligation. On this note, when an executive covered under both an ESOP and LTIP separates from service, it creates a true "repurchase obligation" under the ESOP because the company is required to purchase the ESOP shares. Technically the obligation to monetize the equity-based LTIP award is not a true "repurchase obligation" since there are no shares to be purchased, but we will use the term repurchase obligation generically to refer to the company's total cash outlay needed to settle both the ESOP and LTIP liabilities.