The Compensation Committee Handbook, 4th Edition

CHAPTER 13 Equity-Based Compensation

This chapter describes some of the most common forms of equity-based compensation vehicles, with a focus on their tax and accounting treatment, Section 16 reporting and liability issues under federal securities laws, and an overview of principal advantages and disadvantages of each type of award. It also discusses trends in stock ownership and retention guidelines.

Equity-Based Incentive Awards

Equity compensation plays an essential role in the compensation of executives of public companies. Stock options were the gold standard of employee compensation for many years, but the mandatory expensing of stock options beginning in 2006 eliminated the compelling cost advantage of plain-vanilla stock options over other types of equity awards. This change in accounting rules led to a much broader use of other types of equity-based incentives—in particular, those that focus on the achievement of specific performance objectives rather than simple increase in stock price. Given this evolution, it makes sense for a compensation committee to adopt a flexible incentive plan that permits a variety of award types (often referred to as an omnibus plan). Having a more flexible plan in place allows the committee to tailor individual awards more precisely to address the objectives of both the company and its employees.

This part of the chapter describes some of the most common forms of equity-based compensation vehicles and the related tax, legal, and accounting ...