Non-Execs to Feel More Pain on Option Grant Cutbacks

July 26, 2004 (PLANSPONSOR.com) - The people most likely to get hurt by companies' cutting back their stock compensation awards because of changing accounting standards don't work in the c-suite.

A new survey by Mellon Financial Corporation’s Human Resources & Investor Solutions (HR&IS) business found that 74% of participants expect to cut out or cut back stock grants to non-executives while only one in five ( 21%) expect such cuts for executives. Compounding this difference, the study finds that the majority of companies with discounted employee stock purchase plans will be trim back those programs as they become more costly for employers.

Under FASB’s Exposure Draft issued on March 31, all forms of share-based payments to employees would be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award generally would be measured at fair value at the grant date (See The Bottom Line: Expensing Proposition ). To arrive at this cost, FASB provided several valuation techniques in the Exposure Draft, including a lattice model (an example of which is a binomial model) and a closed-form model (an example of which is the Black-Scholes-Merton formula) that would meet the criteria for estimating the fair values of employee share options

“In response to FASB’s (Financial Accounting Standards Board) expensing proposal, the fundamental finding on equity compensation is one of disparate impact,” said Brett Harsen, a senior consultant in Mellon’s compensation consulting practice, in a news release. “While stock compensation will not be abandoned entirely, it will certainly result in greater cuts for rank-and-file employees than for executives.”

Survey findings also showed that 65% of respondents admit they don’t really understand the binomial option valuation model (FASB’s preferred method for measuring the cost of options), but perhaps more importantly, more than eight in 10 say their company auditors haven’t yet provided any guidance on interpreting the exposure draft.

The survey studied more than 100 companies in June 2004 from a range of industries that currently grant stock compensation. It is available by contacting Brett Harsen at (508) 460-8092 or e-mail at harsen.b@mellon.com .

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