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Unqualified Broad Stock Options
If
an employer does not want to accept the restrictions
applying to qualified broad stocks options as
described above, he may decide to use unqualified
options, in which tax is payable on exercise
by the employee (and the employer can take a
deduction). This is often the case in whole-company
stock option schemes.
Stock
options, stock bonuses, and stock purchase plans
are increasingly used to provide incentive compensation
at all organisational levels to merge the interests
of employees, managers, and investors. For employers
implementing stock ownership plans in which
the underlying stock is subject to regulation
under the Securities Exchange Act of 1934, as
amended, additional considerations, including
securities registration, proxy disclosure, and
short-swing profit liability, should be addressed
before implementing a plan. In addition, generally,
the non-ESOP equity incentive plans are not
subject to requirements of ERISA; however, any
equity incentive plan which systematically defers
payments to the termination of employment or
retirement could trigger application of ERISA.
Virtually
all broad stock option plans are structured
as nonqualified options. A company will give
employees either a one-time or annual option
grant (the right to purchase shares at a fixed
price, usually the market price at the day of
the grant) based, in most cases, on a percentage
of pay, a merit formula, or, less commonly,
on an equal basis. The options are typically
subject to three to five-year vesting, meaning
that if someone is 20% vested, he or she can
only exercise 20% of the options. An employee
can usually exercise vested options at any time.
Most public companies offer a "cashless
exercise" alternative in which the employee
exercises the option, and the company gives
the employee an amount of stock equal to the
difference between the grant price and the exercise
price, minus any taxes that are due. The employee
must pay ordinary income tax on the "spread"
between the grant and exercise price; the company
can deduct that amount.
In closely held companies, employees usually
have to wait until the company is sold or goes
public to sell their shares, although some companies
have arrangements to purchase the shares themselves
or help facilitate buying and selling between
employees. When an employee exercises an option,
however, this constitutes an investment decision
subject to securities laws. At a minimum, these
require "anti-fraud financial disclosure
statements" and, in some cases, will require
securities registration as well. For this reason,
broad stock options are used primarily in closely
held companies when the intention is to sell
or go public.
Using
employee stock ownership as an incentive compensation
device provides many benefits for both the employer
and the employee. The success of any employee
stock ownership plan depends on the employer
choosing the correct plan to achieve the desired
goals. In selecting an equity incentive plan,
the employer must decide what group of employees
he/she would like to reward, how closely he/she
wants the reward to be tied to performance goals,
what type of performance goals would work for
the employees, and how the equity incentive
plan could be used with work incentives currently
in place.
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