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3rd Quarter 2012
commensurate with the level of contribution
and effort delivered?
as a result, the structures of long-term incentive
plans are undergoing a transformation. specifi-
cally, some companies have deemphasized the
use of stock options and begun introducing other
time- and performance-based equity vehicles that
promote a long-term share ownership perspective
for executives and senior management.This strat-
egy closely aligns executives and senior manage-
ment interests with achievement of longer-term
financial objectives that enhance shareholder
value, while at the same time limiting the dilutive
effects of previous stock option grants.
RSUs Versus SARs
The most prevalent shift is the increasing use
of restricted stock units (rsus), which are
considered full-value awards, and stock ap-
preciation rights (sars), which are considered
appreciation value awards. These equity ve-
hicles help lower shareholder dilution because
a company can issue fewer shares to provide
the same prior year value as compared to stock
options. some companies have replaced stock
options entirely with either rsus or sars or
a combination of both, while other companies
are complementing stock options with rsus,
sars, or a combination of both.
in determining whether an rsu or sar is
the right choice, companies should ensure their
compensation strategies meet their business
strategy, market characteristics, and talent
needs. Just as a company’s business strategy is
unique and crafted to create an advantage over
its competitors, compensation strategy should
also fit the distinct business. business and talent
needs should also help in the decision about
which vehicles are right for the company and
business strategy.
When considering an rsu or sar, a com-
pany should look at the following elements:
Business needs and market characteristics.
Consider business stages and growth potential.
for example, a mature company with limited
growth potential may favor rsus. These are
also appropriate for a company focused on total
return to shareholders, dividends and cash flows,
or for one experiencing high stock volatility. in
contrast, a company in a high-growth phase or
with high stock appreciation or low stock volatil-
ity might consider sars.
Talent needs and characteristics.
if employees are more comfort-
able with vehicles that offer a
lower risk and, in exchange, a
lower reward, rsus may be
appropriate. a company with a
high risk of turnover should also
consider rsus. The opposite
situation of high risk and reward
or low turnover favors sars.
Performance/rewards philosophy.
use rsus to insulate employees
from downside risk in a falling
market or provide moderate
wealth-accumulation
opportunities. sars provide
greater upside potential and risk
along with significant wealth-
accumulation opportunities.
What is an RSU?
an rsu is an arrangement whereby no grant of
shares is made, rather the individual is granted
units, with each unit equal in value to a share
of stock on the grant date. on satisfaction of a
vesting requirement, the individual is entitled
to shares equal to the current value of the units.
Compared to a stock option, an rsu results
in fewer shares being issued, since it provides
the individual with less downside risk. typi-
cally, most companies grant an rsu award
equal to 30 to 50 percent of a stock option
award. The reason is that an rsu will always be
worth something, as the individual will always
receive the same number of shares of common
stock upon vesting. additionally, the shares will
have value to them, regardless of whether the
stock price declines after the grant date. Thus
rsus will almost always provide compensation
to an individual in a down market, since they
are almost always in the money, compared to a
stock option, which could be underwater. for
this reason, an rsu would be more favorable to
a stock option for the individual.
from the perspective of investors and
shareholders, when an rsu vests, the em-
ployee is in the same shoes as a shareholder,
since they then have voting and dividend
rights, which encourage a sense of ownership
and identification with the company. as a re-
sult, closely aligning employ-
ees’ interests with achieve-
ment of longer-term financial
objectives of the company
enhances shareholder value.
for example, if a company
grants 10,000 stock options
having an exercise price or
“strike” price (the stock price
on the date of grant) of $5,
and subsequently it falls to $3,
the stock option is under-
water and worthless. on the
other hand, if 4,000 rsus are
granted and on the vesting
date the stock price is $3,
the individual would receive
4,000 shares of common stock
valued at $12,000, which is
taxed as ordinary income.
it is important to note that the individual
does not receive any cash on the vesting date.
he or she is responsible for taxes on the vesting
date. The way the taxes are paid is determined
by the company either by net share settlement
(selling enough shares of the company’s com-
mon stock to cover the taxes) or the individual
paying cash. The individual may elect to sell the
shares on the vesting date or might consider
holding onto them, believing that the stock
price will increase.
in the case of a net share settlement, the
individual will never be in a cash-loss position,
because shares were sold on the vesting date to
cover the taxes. subsequently, if shares are sold,
the individual has capital gains or losses based
on the holding period, which begins at the time
of vesting. The tax basis is the amount included
as ordinary income.
in the case of paying cash for taxes, the
individual could potentially be in a cash-
loss position if the stock price significantly
decreases and is unable to sell for a period
of time due to restrictions placed by the
company. most companies carry restrictions
prohibiting the sale of shares over a period of
time based on (1) black out periods for earn-
ings releases, and (2) liquidity events such
as capital raises and merger-and-acquisition
transactions that limit the amount of shares
entering the market.
CoNsidEriNG THE (sToCK) oPTioNs
“
A COMPANY
WITH A
HIGH RISK OF
TURNOVER
SHOULD ALSO
CONSIDER
RSU’S. THE
OPPOSITE
SITUATION …
FAVORS
SAR’S.
”