Post by Sapphire Capital on Oct 22, 2008 7:33:52 GMT 4
Are Tax and Accounting Rules Discriminating against Discounted Employee Stock Options Justified?
David I. Walker
Boston University School of Law
September 17, 2008
CLEA 2008 Meetings Paper
Boston Univ. School of Law Working Paper No. 08-30
Abstract:
Contemporaneous grants of both stock and at-the-money options to individual employees of U.S. public companies indicates demand for equity compensation packages that are in the money, i.e., packages of equity pay instruments that in aggregate have payoff profiles and incentive properties that are similar to explicit in-the-money employee stock options. However, several tax rules (and formerly accounting rules) strongly discourage grants of explicit in-the-money options, including recently enacted IRC subsection 409A, which essentially precludes the use of explicitly discounted options by taxing these instruments at vesting, rather than at exercise. This article explores whether the tax and accounting distinction between discounted and non-discounted options makes sense.
The stated legislative rationales for rules discriminating against explicit in-the-money options are weak, reflecting a dichotomous view of equity compensation divided between discounted and non-discounted options, when, in fact, option design is a continuum. However, there is a tax policy rationale for forcing firms to bifurcate in-the-money pay packages into discrete grants of stock and at-the-money options, a combination that I refer to as a synthetic in-the-money option. In short, doing so precludes the unwarranted expansion of preferential option tax treatment to instruments resembling restricted stock. But there is a cost if firms are forced to utilize suboptimal compensation schemes. The extent of the cost depends in large part on how close a substitute synthetic in-the-money options are for the real thing. This article argues that the two are close, but not perfect, substitutes. Thus, at this stage of the investigation, this article identifies opposing benefits and costs to rules discriminating against discounted options, yielding indeterminacy, rather than a clear policy prescription.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1152312_code254274.pdf?abstractid=1152312&mirid=1
David I. Walker
Boston University School of Law
September 17, 2008
CLEA 2008 Meetings Paper
Boston Univ. School of Law Working Paper No. 08-30
Abstract:
Contemporaneous grants of both stock and at-the-money options to individual employees of U.S. public companies indicates demand for equity compensation packages that are in the money, i.e., packages of equity pay instruments that in aggregate have payoff profiles and incentive properties that are similar to explicit in-the-money employee stock options. However, several tax rules (and formerly accounting rules) strongly discourage grants of explicit in-the-money options, including recently enacted IRC subsection 409A, which essentially precludes the use of explicitly discounted options by taxing these instruments at vesting, rather than at exercise. This article explores whether the tax and accounting distinction between discounted and non-discounted options makes sense.
The stated legislative rationales for rules discriminating against explicit in-the-money options are weak, reflecting a dichotomous view of equity compensation divided between discounted and non-discounted options, when, in fact, option design is a continuum. However, there is a tax policy rationale for forcing firms to bifurcate in-the-money pay packages into discrete grants of stock and at-the-money options, a combination that I refer to as a synthetic in-the-money option. In short, doing so precludes the unwarranted expansion of preferential option tax treatment to instruments resembling restricted stock. But there is a cost if firms are forced to utilize suboptimal compensation schemes. The extent of the cost depends in large part on how close a substitute synthetic in-the-money options are for the real thing. This article argues that the two are close, but not perfect, substitutes. Thus, at this stage of the investigation, this article identifies opposing benefits and costs to rules discriminating against discounted options, yielding indeterminacy, rather than a clear policy prescription.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1152312_code254274.pdf?abstractid=1152312&mirid=1