Companies Rush To Accelerate Stock Option Vesting

More than 100 companies have rushed to accelerate the vesting of their stock options before new accounting rules go into effect that require them to expense the value of out-of-money options and other stock-based compensation.

And even though the Securities and Exchange Commission last week pushed back the day calendar-year companies must begin top adopt this new accounting standard by six months, experts don’t anticipate the movement among companies to accelerate the vesting of stock options to abate.

For one thing, many companies will not even benefit from the delay. They include companies with June 30, July 31, and Aug. 31 year-ends, which still need to adopt the new rules in the next quarter.

Indeed, the extra six months that most companies just received “provides more time for companies to window dress the impacts through acceleration of vesting, tweaking assumptions, and other maneuvers,” according to the accounting team at Bear Stearns.

As of early April, Bear Stearns counted 102 companies that accelerated the vesting of options.

“Perceived” Accounting Benefit

The reason is very simple. When Statement 123R goes into effect, companies will begin amortizing to income the grant-date fair value of all unvested options.

So, by vesting out-of-the-money options, the future stock option expense from these options will vanish from the income statement, Bear Stearns explains in a recent report. "That is, companies will record the unamortized fair value of those options only in the footnote disclosure to their financial statements in the period in which options' vesting is accelerated,” it elaborates.

“We weren’t surprised [by the large number of companies that accelerated the vesting],” concedes Shan Benedict, of the SEC’s office of the chief accountant.

Indeed, Chad Kokenge, professional accounting fellow, SEC’s office of the chief accountant, acknowledged this possibility in a speech delivered back in December. “We are aware of an issue that has surfaced as companies prepare to adopt the fair value model for recognizing compensation expense for employee stock options,” he said, referring to the acceleration of vesting of stock options having an exercise price in excess of the stock's current market price. “We understand the ‘perceived’ accounting benefit for modifying the awards to accelerate the vesting before adopting the new standard is that it allows the company to accelerate the ‘recognition’ of compensation cost such that it only impacts the fair value pro forma disclosures required under FAS 12.”

Kokenge went on to say that there are two schools of accounting thought on this issue—one proposing that no acceleration of compensation cost should be allowed upon modification under the guidance in FAS 123, and one that would allow for an acceleration of recognition of compensation cost.

“One point in FAS 123 is clear,” Kokenge added. “For each year an income statement is provided, the terms of significant modifications of outstanding awards shall be disclosed…Disclosure of any modifications to accelerate the vesting of out-of-the-money options in anticipation of adopting the new accounting standard is necessary.”

However, when the SEC published Staff Accounting Bulletin No. 107 on March 29, the Bear Stearns folks point out that the Commission “only admonished companies to include clear disclosure and the reasons for why they are accelerating the vesting of employee stock options” and did not go so far as decide to change the accounting for accelerated vesting. “Based on our review of disclosures thus far, companies have been quite candid in explaining the reasons for vesting stock options—to lower expense recorded in the income statement going forward and, in some cases, to improve employee morale,” it points out.

Out And Back In The Money

The postponement of the new accounting standard’s implementation date certainly removes the urgency for companies to accelerate the vesting of options. But, it shouldn’t slow down the pace, experts say.

“This [the six-month postponement] provides a breather if you should consider it,” says Tim Ranzetta of compensation consultants Equilar.

Some companies benefit more than others from accelerating the vesting of their options. For example, Ranzetta asserts that companies whose stocks are currently way below the option strike price should be among the ones that most seriously consider this practice. “Otherwise, they will incur a huge expense that doesn’t reflect reality,” he adds.

However, Bear Stearns found that at 19 of the 102 companies that accelerated the vesting, the options vested are either in-the-money or out-of-the-money by less than 15 percent based on the share prices at the time the report was published in early April.

In fact, at the time—before the stock market’s recent sell-off—accelerated, vested out of the money options were already in the money for three companies—Jabil Circuits, HCA and McKesson.

Some companies, however, are apparently sensitive that they are quickly enriching their already high-paid executives by accelerating the vesting and removing the ostensible reason for having options in the first place—to provide a good retention tool.

So, at least two companies have announced plans to accelerate unvested options for all employees except a select group of executives. They include Whole Foods Markets and Triquint Semiconductor.

Whole Foods, a chain of natural and organic foods supermarkets, said it would accelerate the vesting of the options held by its employees but not its top executives. And Triquint Semiconductor said it accelerated the vesting of options, excluding option grants, to board members and the chief executive officer.

Others are accelerating the vesting but requiring executives and employees to hold onto them and not exercise the options so there is no quick windfall. They include Applera, a biotech company, and Ligand Pharmaceuticals.

In a recent 8-K, Applera states, “shares received upon the exercise of accelerated options held by directors, officers, and certain other senior managers, including all of Applera’s executive officers, may not be sold prior to the earlier of the original vesting date or their termination of employment or service.”

In its regulatory filing, Ligand said executive officers plus other members of senior management have agreed that they will not sell any shares acquired through the exercise of an accelerated option prior to the date on which the exercise would have been permitted under the option's original vesting terms.

Says Ranzetta: “While we have seen many companies accelerate any options with exercise prices higher than the stock price on the date of the announcement, some have chosen to require executives to hold their shares until the original vest date, thus ensuring these now vested options have some retentive value.”