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A Glossary (of Sorts) of Executive Compensation Terms
by Frank Monahan
Executive compensation is quite a hot topic these days. I thought it
would be helpful to provide you with a kind of primer for some of the
more popular terms. Typically when the government comes up with a
new regulation, it identifies it by a number and a letter. While there are
only 26 letters in the alphabet, there are an infinite number of numbers.
Consequently, there is no limit to the number of government sponsored
combinations. Here are a few of the more popular ones that pertain to
executive compensation with a brief description. I thought it might be
helpful to add my own rendition of a government translation. Please
note that the real description in brackets may not be as precise as your
attorneys might prefer but my translation should be spot on.
I.R.C. (Internal Revenue Code)
83(b) election [Allows employees awarded stock to elect to be taxed at
fair market value on grant date rather than when restrictions lapse
provided it is filed within 30 days of grant.] Translation: you get to
choose when you’ll be taxed and if you get it wrong, We in Government
win big time.
280(g) [Added to the I.R.C. in 1984, this section pertains to the golden
parachute arrangements that companies have with the executive in the
case of Change in Control.] Translation: we really don’t care if your
golden parachute doesn’t open up, in fact, We in Government really want
you to hit the ground with a thud or at least bounce less than 2.99 times.
409(a) [Added to the IRC in October 2004, and introduces much stricter
regulation of deferred compensation. Violations may result in an
additional 20% federal, interest and penalties. Furthermore, states are
allowed to get in on the action, as well. If you want to understand this
section more clearly, you will need an army of lawyers.] Translation:
when we got to section 885 of the Jobs Creation Act of 2004, we
recognized that we needed to add something to prevent another Enron
like fiasco. We in Government made the determination that we shouldn't
call it 885a because it wasn’t really a good mnemonic. So, we decided
to lower the number and make it more memorable. At the end of the
day, we tried to get executives to permanently defer payments to us but
settled for this compromise which allows them not to accelerate
deferred payments whenever they felt in the mood, among other things.
401(k) [Added in 1978, this piece of the IRC allowed an employee
benefit sponsored by an employer that allows an employee to save for
retirement by deferring income.] Translation: we have no idea how the
Social Security program we created in 1935 will be funded by the time
you retire, so we created another program for you and your employer to
fund yourselves. Due to contribution limits, this provision is not sufficient
to cover an executive so please refer to the section 409(a) above. We in
Government are doing everything in our power to ensure financial
security for your old age but none of us think we’ll be very successful.
Therefore, we are going to dabble with the health care system to ensure
that not as many people will be able to reach old age. Please stay tuned.
Other
Section 16 [Applies to directors, officers and principal stockholders or
any beneficial owner of 10% or more of any non-exempt security.]
Translation: the first fifteen sections were kind of blah blah blah but we
really hit our stride with this little gem. We in Government want to make
it really hard for the people sitting in this section of the corporation to sell
their shares when the price is actually high so we make them jump
through all sorts of hoops.
NEO [This stands for named executive officers.] Translation: To date We
in Government have not encountered any executives who were unnamed
but we get a kick out of calling these guys named. And over at the SEC
we are really into plain language these days. After all, the guys over at
Justice like to name co-conspirators and such so this is kind of like that
except we only get to name them, for now.
Section 404 (SOX 404) [Public Company Accounting Reform and
Investor Protection Act of 2002, this little treasure is also known as
Sarbanes-Oxley, Sarbox or SOX. In response to a number of scandals
including Enron, Tyco and Worldcom, new standards were established
for public companies. The bill was sponsored by Senator Paul S.
Sarbanes (D-MD) and Michael G. Oxley (R-OH).] Translation: When
confronted with a scandal of this size and magnitude, We in Government
did the only thing that we could think of, we introduced the mother of all
regulatory standards. We know it cost companies a lot of money but we
had lots of friends in the accounting profession and they needed the
work.
FAS123 (R) [Financial Accounting Standards Board issued new
regulations designed to improve upon APB Opinion 25, Accounting for
Stock Issued to Employees which used a fair value methodology for
valuation.] Translation: The use of the (R) meant that we had a revision
even before this really hit the street. We in Government thought
something labeled as an “opinion” sounded kind of wimpy so we
decided to put the full weight of the Financial Accounting Standards
Board behind it. While we knew people could understand the intrinsic
value calculation under APB 25, we knew they would have difficulty with
the Black-Scholes model in the new standard. And to see everyone
squirm trying to figure out the Binomial Lattice model is something that
is just plain fun for the folks over at FASB.
© Frank Monahan 2009
by Frank Monahan
Executive compensation is quite a hot topic these days. I thought it
would be helpful to provide you with a kind of primer for some of the
more popular terms. Typically when the government comes up with a
new regulation, it identifies it by a number and a letter. While there are
only 26 letters in the alphabet, there are an infinite number of numbers.
Consequently, there is no limit to the number of government sponsored
combinations. Here are a few of the more popular ones that pertain to
executive compensation with a brief description. I thought it might be
helpful to add my own rendition of a government translation. Please
note that the real description in brackets may not be as precise as your
attorneys might prefer but my translation should be spot on.
I.R.C. (Internal Revenue Code)
83(b) election [Allows employees awarded stock to elect to be taxed at
fair market value on grant date rather than when restrictions lapse
provided it is filed within 30 days of grant.] Translation: you get to
choose when you’ll be taxed and if you get it wrong, We in Government
win big time.
280(g) [Added to the I.R.C. in 1984, this section pertains to the golden
parachute arrangements that companies have with the executive in the
case of Change in Control.] Translation: we really don’t care if your
golden parachute doesn’t open up, in fact, We in Government really want
you to hit the ground with a thud or at least bounce less than 2.99 times.
409(a) [Added to the IRC in October 2004, and introduces much stricter
regulation of deferred compensation. Violations may result in an
additional 20% federal, interest and penalties. Furthermore, states are
allowed to get in on the action, as well. If you want to understand this
section more clearly, you will need an army of lawyers.] Translation:
when we got to section 885 of the Jobs Creation Act of 2004, we
recognized that we needed to add something to prevent another Enron
like fiasco. We in Government made the determination that we shouldn't
call it 885a because it wasn’t really a good mnemonic. So, we decided
to lower the number and make it more memorable. At the end of the
day, we tried to get executives to permanently defer payments to us but
settled for this compromise which allows them not to accelerate
deferred payments whenever they felt in the mood, among other things.
401(k) [Added in 1978, this piece of the IRC allowed an employee
benefit sponsored by an employer that allows an employee to save for
retirement by deferring income.] Translation: we have no idea how the
Social Security program we created in 1935 will be funded by the time
you retire, so we created another program for you and your employer to
fund yourselves. Due to contribution limits, this provision is not sufficient
to cover an executive so please refer to the section 409(a) above. We in
Government are doing everything in our power to ensure financial
security for your old age but none of us think we’ll be very successful.
Therefore, we are going to dabble with the health care system to ensure
that not as many people will be able to reach old age. Please stay tuned.
Other
Section 16 [Applies to directors, officers and principal stockholders or
any beneficial owner of 10% or more of any non-exempt security.]
Translation: the first fifteen sections were kind of blah blah blah but we
really hit our stride with this little gem. We in Government want to make
it really hard for the people sitting in this section of the corporation to sell
their shares when the price is actually high so we make them jump
through all sorts of hoops.
NEO [This stands for named executive officers.] Translation: To date We
in Government have not encountered any executives who were unnamed
but we get a kick out of calling these guys named. And over at the SEC
we are really into plain language these days. After all, the guys over at
Justice like to name co-conspirators and such so this is kind of like that
except we only get to name them, for now.
Section 404 (SOX 404) [Public Company Accounting Reform and
Investor Protection Act of 2002, this little treasure is also known as
Sarbanes-Oxley, Sarbox or SOX. In response to a number of scandals
including Enron, Tyco and Worldcom, new standards were established
for public companies. The bill was sponsored by Senator Paul S.
Sarbanes (D-MD) and Michael G. Oxley (R-OH).] Translation: When
confronted with a scandal of this size and magnitude, We in Government
did the only thing that we could think of, we introduced the mother of all
regulatory standards. We know it cost companies a lot of money but we
had lots of friends in the accounting profession and they needed the
work.
FAS123 (R) [Financial Accounting Standards Board issued new
regulations designed to improve upon APB Opinion 25, Accounting for
Stock Issued to Employees which used a fair value methodology for
valuation.] Translation: The use of the (R) meant that we had a revision
even before this really hit the street. We in Government thought
something labeled as an “opinion” sounded kind of wimpy so we
decided to put the full weight of the Financial Accounting Standards
Board behind it. While we knew people could understand the intrinsic
value calculation under APB 25, we knew they would have difficulty with
the Black-Scholes model in the new standard. And to see everyone
squirm trying to figure out the Binomial Lattice model is something that
is just plain fun for the folks over at FASB.
© Frank Monahan 2009
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