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The Employee Ownership Update

Corey Rosen

November 11, 2003

(Corey Rosen)

Will Broad-Based Equity Survive Expensing?

Three recent surveys provide information on how companies will react to requirements that options, ESPPs, and other equity awards be shown as an expense on their income statements. The surveys consistently show that somewhat under half of the companies responding plan to cut back the eligibility and/or the size of grants for employees below management levels. On the other hand, very few companies have any intention of reducing eligibility or the size of awards at the senior executive level, and relatively few at the management level. In addition, a third to 45% of the companies plan either to eliminate employee stock purchase plans or change their structure so as to provide lower discounts, eliminate their "look-back" feature, or shorten their offering periods. The ironic result is that the effect of expensing reform could be used by some corporate boards to further concentrate ownership in the hands of a small number of highly paid people.

These surveys need to be viewed with some caution. First, expensing may turn out to be less of an issue than now expected (research points in that direction). Second, the job market could recover, creating the same kinds of labor market conditions that prevailed a few years ago that had companies competing for labor with ownership stakes. It could be very difficult for a company to eliminate its options or its ESPP (or cut back substantially on its benefits) when competitors continue to offer these plans. The surveys indicate that over half of the companies plan to keep their programs intact, a number we expect to end up somewhat higher as the specter of expensing becomes less threatening.

The surveys are:

A more detailed summary of the data will appear in the NCEO's January/February 2004 newsletter.

NESTEG Bill Allows S ESOPs to Use All Distributions to Pay for Loans

In September, the Senate Finance Committee passed the National Employee Savings and Trust Equity Guarantee Act, a broad retirement plan reform bill that contains many of the same provisions passed the year before to address post-Enron concerns about diversification of employee stock in 401(k) plans. The bill also contains a provision that would allow S corporation ESOPs to use all distributions on trust-held shares (not just the unallocated shares-those that have not yet been paid for) to repay an ESOP loan. The change would create a parallel treatment between S corporation ESOPs and C corporation ESOPs that use dividends to repay loans. While the bill has bipartisan support in the Senate, it has not yet made it to the floor, and the House has no comparable legislation to date. Congress will adjourn this year without passing the bill; the outlook for next year is very uncertain as momentum for retirement reform wanes.

FASB, IASB Move Forward on Expensing; 2005 Implementation Date Likely

The Financial Accounting Standards Board (FASB) announced at its October 29, 2003 meeting that its new standards for equity compensation expensing would be effective for accounting periods starting in 2005, similar to the plan of the International Accounting Standards Board (IASB). FASB also announced that it would provide draft standards in February of 2004. FASB will require companies to adopt a "modified prospective" method for accounting for equity pay, so equity awards granted, modified, or settled after the effective date of the new rules, as well as unvested awards, would be covered. Unvested awards, however, would be subject to FAS 123 treatment, not whatever new standards are developed. IASB is taking a similar approach.

IASB also agreed, albeit reluctantly, to go along with FASB on the issue of treating the tax effects of equity pay not as an income item but as a credit or debit to paid-in capital. IASB also agreed to FASB's approach to treat each reload option grant as a new award, rather than being projected as a cost at the first granting of an award with a reload feature. Finally, in a potentially significant decision on performance vested awards, FASB has tentatively decided that companies can reverse compensation costs for awards that fail to vest for service or performance considerations. However, performance must be measured solely with reference to the company's own performance (profits, sales, etc.) rather than with reference to an external index, such as how the company's stock price does relative to other companies. This kind of market-based indexing has been a favorite proposal of reformers, but may be discouraged by these rules.

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