Equity Compensation
Continues Shift Towards Restricted and Performance-Based Stock
March 2006

Calculating Stock Option Value for Expensing and Employee Communications
The Black-Scholes option pricing model is the most commonly used method of calculating the value of employee stock options. Eighty-seven percent of companies use this method for purposes of expensing options (Table 2). Nearly all companies use the same valuation method when reporting the option expense on financial statements and communicating the value of the options to employees.
 

Table 2: Method of Calculation Stock Option Value
Method	Percent of Companies
Black-Scholes Option Pricing Model	87%
Binomial Option Pricing Model	12%
Monte Carlo Simulation Model	1%

Changes in Option-Based Plans
Seventy-three percent of companies plan to make, or have made, changes to their option-based compensation plans. All of the changes involved a reduction of the use of options with 48 percent reducing the number of employees receiving options and 44 percent reducing the total number of options granted (Table 3). One-third of the companies will be replacing some or all of the stock options with shares of restricted stock or restricted stock units. 

Changes in Employee Stock Purchase Plans (ESPPs)
Fifty-nine percent of companies plan to make, or have made, changes to their employee stock purchase plans. The most common change is an elimination of the "look-back" feature, which allows an employee to purchase stock at the lowest price within a specified time-frame (Table 4). Seventeen percent of companies with ESPPs plan to eliminate this employee benefit.

Summary
Companies continue to adjust equity-based compensation plans in response to expensing requirements now placed on these plans. The trend is toward reduction of the reliance on stock options and an exploration of other equity vehicles, mainly restricted stock, restricted stock units, and performance-based stock. Changes are not limited to stock option plans, with over half of companies also planning to alter or eliminate their Employee Stock Purchase Plans.
 

Data source: February 2006 Culpepper Pay Trends Survey of 90 companies.
Median size: 524 employees with a minimum of 4 and maximum of 42,000.
Breakdown by Sector: 36 percent software, 18 percent IT services, 13 percent hardware/electronics/semiconductor, 12 percent life sciences,  9 percent eBusiness,  9 percent telecom and 3 percent other.

Definitions of Equity-Based Compensation Plans

Qualified Stock Options (ISO's) - Incentive stock option plans qualified to receive special tax treatment under section 421(a) of the IRS tax code.

Non-Qualified Stock Options - Options granted that do not meet requirements for favorable tax treatment.

Restricted Stock - Recipient is granted shares, or a right to purchase shares, often at a discount, whose acquisition or sale is subject to restrictions. Restrictions may include employment tenure, personal performance requirements, or corporate performance requirements.

Performance-Based Stock - Stock grants in which the ultimate number of shares and/or the value of the stock is based upon other performance criteria (e.g., earnings per share growth over a three-year period).

Stock Shares - Stock grants in which there are not set performance criteria, restrictions, or limitations.

Stock Appreciation Rights - Recipient is granted rights to receive the appreciated value of stock at some future date.

Phantom Stock - Recipient receives "paper" units for which value is typically based on book value of a share of stock at the time of grant.

Employee Stock Ownership Plan (ESOP) - A qualified, defined contribution to an employee benefit plan that invests primarily in the stock of the employer company. A company creates a trust fund for employees and funds it through contributions of stock, cash to buy stock, or cash to pay back the ESOP's load to buy stock. The stock thus acquired by the ESOP is then allocated to employee accounts.

Non-Qualified Employee Stock Purchase Plan - A non-qualified plan allowing employees to set aside money for a specified period of time into a company account which is then used to purchase company stock at a specific price. The price is typically set below current market value or less than market value at the beginning of the plan period.

Qualified Employee Stock Purchase Plan - A plan qualified to receive special tax treatment allowing employees to set aside money for a specified period of time into a company account which is then used to purchase company stock at a specific price. The price is typically set below current market value or less than market value at the beginning of the plan period.