The Advisors' Blog

– Liz Dunshee

I blogged a few weeks ago about a framework for executive pay adjustments. This Mercer memo lays out additional considerations specific to “non-performing” performance shares – including available alternatives for this situation, plan provisions, accounting treatment, and disclosure and tax implications. Here’s what it says about accounting treatment:

The accounting treatment of discretionary performance share cancellations, modifications, and replacements differs for awards with nonmarket (e.g., EPS or sales targets) vs. market performance conditions (e.g., TSR). Automatic adjustments that are set out in the plan (“the committee shall adjust for …”) generally have no impact on compensation expense.

Nonmarket conditions. Companies recognize no cost for performance shares that are improbable of vesting or cancelled. Instead, companies must recognize any incremental cost associated with a modified or replacement award. The incremental cost is calculated by comparing the fair value of the award immediately pre- and post-modification. If an award is improbable of vesting or cancelled, the pre-modification fair value is zero and the post-modification value equals the new number of shares expected to vest (typically target) multiplied by the per-share fair value on the modification date. The final cost is trued up for the number of shares that actually vest.

Market conditions. The cost of a performance share with a market condition must be recognized regardless of the outcome or whether the award is cancelled, as long as the employee completes the award’s original service requirement. In addition, companies have to recognize any incremental cost associated with a modified or replacement award. The incremental cost is calculated by comparing the fair value of the award (using a Monte-Carlo simulation incorporating the probability of achievement) immediately pre- and post-modification.

And when it comes to your plan documents, here are a few questions to consider:

– Are there any restrictions on discretionary modifications or replacements?

– Is participant consent required?

– Will cancelling awards or converting stock-settled awards replenish the share reserve?

– Will additional grants exceed the available share reserve or any plan individual limits?