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1st QUARTER 2013 WWW.CFOSTUDIO.COM 33 continued from page 17 provide more upside than for revenues. The reason is that there is a strong relationship between EBITDA or Adjusted EBITDA growth and stock price movements, which ultimately creates shareholder value. As a reality check, companies should compare the payout ranges to comparable companies’. For example, if performance levels are more aggressive than those of comparable companies, then the payouts should also be correspondingly aggressive. If performance levels are less aggressive, the payouts should be correspondingly less aggressive. Selecting the Performance-Based Equity Award The primary objective from a shareholder perspective is to create the right align- ment between their interests and those of executives while minimizing dilution and optimizing their returns. Due to significant losses incurred by shareholders dating back to 2008, companies have been granting performance-based restricted stock units and restricted stock known as full-value awards in favor of stock options. Both these full-value awards offer similar incentives to stock options, since they reward for increases to a company’s stock price, and in that way tie the interests of executives with those of shareholders. However, un- like stock options, these full-value awards provide retention value even if a company’s stock price decreases after the grant date, because the individual will always receive stock, compared to a stock option that is underwater and worthless. Because of this perceived value, companies have been able to offer reduced grant values that were previously offered by stock options, which reduces dilution levels. A restricted stock unit and restricted stock are very similar, but have some basic differ- ences between them. For both awards, the individual is taxed at the vesting date based on the stock price. However, the biggest difference is the tax treatment. The holder of restricted stock can make a Section 83(b) tax election (which needs to be made within 30 days of the grant), which allows the indi- vidual to pay taxes on the fair market value of the award at the time of grant. The holder of a restricted stock unit cannot make such election and will be taxed on the market value of the award on the vesting date as ordinary income. For example, if an individual was granted 20,000 shares of restricted stock and the stock price at the time of grant was $10, that award would have an initial fair market value of $200,000. If 50 percent of the award vests after one year and the stock price is $15 on the vesting date, the individual would have $150,000 of ordinary income. But if the holder of the restricted stock chose to make a Section 83(b) election, the individual would have ordinary income of $200,000 and would have no further tax consequences on the subsequent vesting. However, there is some risk with making a Section 83(b) election. If the stock price subsequently decreases, the individual would have paid too much tax and the overpayment is not refund- able. Likewise, if the award is forfeited or canceled, then any previously paid tax is not refunded. For the above reasons, many individuals are hesitant to make a Section 83(b) election unless the stock price is extremely low at the grant date. Final Thoughts Performance-based equity awards provide a clear link between executives and share- holders, since the ultimate value of awards is based on shareholder value creation. Thus it is important for a company to make a convincing and specific case for its performance measurements to support its business strategy. In some cases companies are implementing performance measure- ments that look very different from those of comparable companies, and that is okay because every company has a different busi- ness strategy. C Getting Pay AlignedWith Performance