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Chapter 5 Module 6: Stock Compensation

Overview:
Stock options provide key employees with the option to purchase common stock at a
specified price over an extended period of time. Stock compensation plans will provide
employees with the following:

Compensatory vs Noncompensatory Stock Option Plans:

Both traditional stock option and stock purchase plans entitle a company to grant options to
purchase company stock at a specified price (generally lower than the market rate). This
enables individuals to have the ability to exercise their option to purchase stock at a
discount and subsequently resell it at its (higher) market price.

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Compensatory:
Compensatory stock options and stock purchase plans are those that are generally offered
as a form of compensation (e.g. in addition to salaries). Compensatory stock option plans
will be measured at their fair market value. The following terms are applicable to
compensatory stock options for recognition purposes:

Exercise date – the date in which the employee (holder of the option) is required to exercise
the option to purchase the stock at the specified rate under the terms of the option contract.
Grant date – the date in which the option is issued to the employee.
Exercise price – the price in which the employee (holder of the option) can (but is not
required to purchase the stock under the terms of the contract.
Fair value of the option – represents the market value of the option which is generally
determined based on the Black-Scholes pricing model.
Vesting / Service period – the period over which the compensation expense will be
recognized and generally represents the time period over which an employee will perform
services in order to obtain the ability to exercise their option(s) (also known as the vesting
period).

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Noncompensatory:
Noncompensatory stock option and purchase plans are benefits that will allow employees to
have the ability to purchase company stock at a specific price within a specific period of
time. These options are most commonly distributed to company employees or executives
within the firm. Noncompensatory stock option will qualify assuming they meet the following
characteristics:
• Most full-time employees that meet limited employee qualification are allowed to
participate. Additionally, executives and those who own a specific amount of
outstanding stock in the corporation will be exempt.
• Stock will be offered to all eligible employees equally. However, the plan may limit the
total amount of shares that can be purchased.
• The time allowed to exercise the options is deemed reasonable.
• Discounts from the market price isn’t greater than what would be a reasonable offer
of stock to shareholders or others.
• Any plans that do not meet the above criteria are considered compensatory stock
option plans.
Compensation expense – is based on the fair value of the options expected to vest on the
date in which the company grants the options to its employee’s. This is also known as the
grant date.
Allocation of compensation expense – compensation expenses should be allocated to the
periods in which their employees perform the services (i.e. the service period).

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