Incentive Plan Overhauls

If adopted as is, the FASB's proposed rule change for stock option accounting could level the playing field in incentive plan design.

Few finance executives were surprised when, in March, the Financial Accounting Standards Board (FASB) issued an exposure draft of a proposed rule change that would require companies to recognize stock option grants as a cost on their income statement, just like any other form of compensation. But the FASB's move confronts CFOs with an urgent question: If the new regulation is adopted, how will it affect their organization's equity-based incentive plan? Although some observers worry about the impact of stock option expensing on companies' balance sheet, the proposed rule, if adopted as it stands, would also create new opportunities in incentive plan design by removing accounting considerations from that activity. For example, since standard plain vanilla options would no longer receive preferential accounting treatment, companies might want to consider offering less-common types of stock options that have always required an accounting expense. In addition, the rule change would level the playing field for a variety of underused incentive vehicles, including more complex types of stock options, by allowing companies to use fixed accounting for these costs rather than the more onerous variable accounting.

Many organizations that offer stock option grants as part of their executive compensation package have never investigated alternative share-based incentive vehicles. "Up to now, many companies -- especially smaller companies -- have limited [their] stock-based incentives to stock options," says Joseph Rich, Boston-based vice chairman of Pearl Meyer & Partners, an executive compensation consulting firm. Yet organizations that want to maximize the effectiveness of their incentive program must look beyond stock options.

The new regulation would help companies ensure that their incentive plan design is driven by what's best for the organization as a whole, rather than what's best for the income statement. "I expect to see a lot more creativity in types of options and stock awards companies make," says Bruce R. Ellig, a New York City-based adviser to corporate boards and author of "The Complete Guide to Executive Compensation" (McGraw-Hill, 2002). Change is already afoot in many organizations, he adds. "Companies were -- or should have been -- making changes during the last round of shareholder meetings," he notes.