Executive compensation is a highly visible and hotly debated issue. Much of the debate has focused on stock-based compensation, particularly stock options and restricted stock. During the past two years, several events have underscored the importance of this issue to accountants.
In October, 1992, the Securities and Exchange Commission (SEC) issued new regulations governing the disclosure of compensation information in the annual proxy statement. In June, 1993, the Financial Accounting Standards Board (FASB) issued its exposure draft on "Accounting for Stock-Based Compensation." Throughout 1993 and 1994, several business periodicals published surveys of CEO compensation. The 1993 Tax Act imposed restrictions on the deductibility of some forms of executive compensation. Also, compensation and benefits consulting has become established as a major growth market for accounting firms of all sizes.
Table 1 lists several Fortune 50 firms ranked by CEO compensation as computed by the Wall Street Journal and Forbes. The table illustrates how different treatments of stock-based compensation can lead to strikingly different amounts of total compensation. There are three companies (General Electric, Merck and Philip Morris) for which the compensation amounts differ by more than $10 million. For Merck, the difference in compensation amounts is almost six times as large as the compensation reported by Forbes. There are also marked differences in rankings under the two different methods of calculating total compensation. For example, Dow Chemical and Ford Motor both moved down 13 positions in the rank ordering, whereas Tenneco moved up 11 positions.
Accountants can profit from an understanding of why such large differences exist and how they can be reconciled. An understanding of the sources of these differences will [TABULAR DATA OMITTED] enhance the ability to assist in the development of compensation policies, compliance with SEC proxy statement disclosure requirements and implementation of the FASB's reporting and disclosure requirements. Unfortunately, accountants who are not compensation specialists seldom have the time needed to wade through the morass of literature dealing with stock-based compensation. In many cases, the non-specialist's previous experience with stock-based compensation is limited to a familiarity with Accounting Principles Board Opinion 25.
This article will assist the non-specialist in acquiring a working knowledge of current developments in accounting for stock-based compensation. It will also show how the identification of the measurement date for stock options and restricted stock is the key to making sense out of stock-based compensation.
Stock Options and Restricted Stock
Stock options give the executive the right to make future purchases of the company's shares at a pre-determined price, known as the striking (or exercise) price. Four dates are of special significance. The grant date is the date on which the options are awarded to the executive. The vesting date is the date on which the executive acquires the right to use the options to purchase shares. The exercise date is the date on which the executive actually uses the options to make a purchase of shares. The expiration date is the last date on which the options can be exercised. Most executive stock options do not become exercisable (i.e., vest) until two or three years after the grant date.
Restricted stock consists of shares of company stock, the ownership of which does not pass to the executive unless and until specified conditions are met. Typical conditions include the passage of time and the achievement of individual and corporate performance goals.
There are two important dates associated with restricted stock. The grant date is the date on which the award is made, i.e., the date on which the company enters into an agreement with the executive that he or she will receive the …