CMS 3, Lesson 9

Which of the following statements about stock appreciation rights is (are) correct? I. The stock appreciation right is a feature many companies use in conjunction with a nonstatutory option. II. Stock appreciation rights are most attractive in times of low-interest rates and high stock price appreciation. III. Stock appreciation rights became more popular when FAS 123R put them and stock options on equal terms for a charge to the earnings statement.

(9.0) I. The stock appreciation right is a feature many companies use in conjunction with a nonstatutory option. III. Stock appreciation rights became more popular when FAS 123R put them and stock options on equal terms for a charge to the earnings statement. Stock appreciation rights are most attractive in times of high-interest rates and low stock price appreciation.

A stock purchase with a 100% discount is called a: A. Stock award B. Stock option C. Letter stock D. Performance share E. Qualifying disposition

(9.0) A. Stock award

All the following are attractive situations in which restricted stock awards may be given to company executives EXCEPT: A. A form of golden handcuffs to retain key talent B. A front-end bonus to hire a top executive without distorting the compensation program C. When the executive wishes to assign, transfer and sell the stock without a tax liability D. A company in the mature phase with reduced opportunities for growth in market value of company stock E. A privately held company interested in tying payment to book value in order to avoid the market swings of publicly traded stock

(9.0) C. When the executive wishes to assign, transfer and sell the stock without a tax liability

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the plan must specify what two things?

(9.1) 1. Employees or classes that are eligible 2. Number of shares available for grant

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the value of the grant may not exceed $__ per person with limited carryover to subsequent years.

(9.1) $100,000

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that grants under the plan may not be later than __ year(s) from adoption or the approval date of the plan.

(9.1) 10 years

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the exercise period generally may not exceed __ year(s) from the date of grant.

(9.1) 10 years

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that shareholders approve the plan within __ months of the date it is adopted.

(9.1) 12

The 1978 Revenue Act changed the untaxed portion of capital gains income to no longer be subject to the __ percent preference tax.

(9.1) 15

The 1997 Taxpayer Relief Act lowered the long-term capital gains rate to 20 percent for those assets held 18 months or longer, while retaining a 28 percent rate for those held more than __ month(s) but less than __ month(s).

(9.1) 18 months, 12 months

Which act reduced the portion of long-term gains subject to taxes from one-half to 40 percent, which lowered the maximum capital gains tax rate from 35 to 28 percent?

(9.1) 1978 Revenue Act

Which act removed the rule that the untaxed portion of capital gains was subject to a 15 percent preference tax?

(9.1) 1978 Revenue Act

Which act restored statutory stock options, which are now referred to as incentive stock options (ISO)?

(9.1) 1981 Economic Recovery Tax Act

Which act lowered the long-term capital gains rate to 20 percent for assets held 12 or more months (previously, the act lowered the rate to 20 percent for assets held 18+ months but retained the 28 percent rate for assets held 12-18 months)?

(9.1) 1997 Taxpayer Relief Act

The 1997 Taxpayer Relief Act lowered the long-term capital gains rate to __ percent for those assets held __ month(s) or longer, while retaining a 28 percent rate for those held more than 12 months but less than 18 months.

(9.1) 20, 18 months

The 1978 Revenue Act reduced the portion of long-term gains subject to taxes from 50 to 40 percent, thus effectively lowering the maximum capital gains tax rate from __ to __ percent.

(9.1) 35 to 28

The 1978 Revenue Act reduced the portion of long-term gains subject to taxes from __ to __ percent, thus effectively lowering the maximum capital gains tax rate from 35 to 28 percent.

(9.1) 50 to 40

Which IRC section defines restricted stock options?

(9.1) IRC Section 424

The 1981 Economic Recovery Tax Act restored statutory stock options, which are now referred to as what?

(9.1) Incentive stock options (ISO)

Does the qualified stock option impose a tax liability on the taxholder? If so, when (e.g., at grant or exercise)?

(9.1) No; like the restricted stock option, the qualified option imposes no tax liability on the taxholder either at time of grant or exercise.

The Revenue Act of 1964 terminated the restricted form of option and introduced what new form of statutory option?

(9.1) Qualified option

What was the first stock option form that received favorable tax treatment?

(9.1) Restricted option

What three things did the 1969 Tax Reform Act do to affect qualified stock options?

(9.1) The 1969 Tax Reform Act: 1. Lowered the maximum marginal tax rate from 70 to 50 percent on earned income 2. Increased the long-term capital gains tax maximum of 25 percent to one-half the ordinary income tax rate (except for the first $50,000, which was still subject to a 25 percent rate) 3. Introduced a new form of tax called the alternative minimum tax (AMT)

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the optionee incurs no ordinary income upon grant or exercise of an ISO but may be subject to the ______.

(9.1) alternative minimum tax (AMT)

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that they (are/are not) subject to discrimination requirements.

(9.1) are not

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the grant price may not be less than the fair market value on the date of ______.

(9.1) grant

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the option (is/is not) transferrable.

(9.1) is not

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the grant price may not be (less/more) than the fair market value on the date of grant.

(9.1) less

Legislative changes made nonqualified stock options comparatively (more/less) attractive.

(9.1) more

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the optionee must be an employee and exercise the option not later than __ month(s) after leaving employment, __ year(s) for disability or to term for death.

(9.1) three months, one year

The 1981 Economic Recovery Tax Act restored statutory stock options with the requirement that the optionee may not sell the acquired shares sooner than __ year(s) from the date of grant or within __ year(s) after exercise.

(9.1) two years, one year

Does interest accumulate on stocks under a stock purchase plan?

(9.10) Often, the company gives the person a low-interest or no-interest loan to purchase the stock.

How are stock paid out under a fixed cost, fixed basis stock purchase plan?

(9.10) The basis for payment is a specified yearly schedule that will pay for the stock over a stated period of years or in a lump-sum payment at the end of a defined period.

What is the typical cost of stock under a stock purchase plan when the offer is made to the executive?

(9.10) The cost might be at or below market value of the stock at the time the offer is made.

What act prohibits company loans to executives and directors?

(9.11) 2002 Sarbanes-Oxley Act

Are loan forgiveness amounts charged to company earnings?

(9.11) Yes

Are loan forgiveness amounts considered a tax deduction to the company?

(9.11) Yes

Are loan forgiveness amounts reported as income for the executive?

(9.11) Yes

The variable cost and variable basis for payment of an executive stock purchase plan is a combination of two variable formulas, which determine what factors?

(9.13) 1. Cost 2. The extent of foregiveness

Which of the following formulas is most complex? A. Fixed cost, variable basis B. Variable cost, fixed basis C. Variable cost, variable basis D. None of the above

(9.13) C. Variable cost, variable basis

What is a stock award?

(9.14) A stock award is a stock purchase with a 100 percent discount.

What is a stock unit?

(9.14) A stock unit is the right to receive a share of company stock at a specified time in the future.

What term describes a stock purchase with a 100 percent discount?

(9.14) Stock award

What term describes the right to receive a share of company stock at a specified time in the future?

(9.14) Stock unit

What three ways can stock be restricted?

(9.15) 1. Vested solely on remaining with the company to a specified date 2. Vested solely on remaining with the company to a specified date with earlier payment if prescribed performance requirements have been met 3. Performance-only vesting

An executive cannot assign, transfer or sell restricted stock awards; however, he or she can do what three things?

(9.15) 1. Possess the stock certificate 2. Receive dividends earned on the stock 3. Vote on the stock

What is career-restricted stock?

(9.15) A career-restricted stock is a restricted stock with a long restriction period.

What four ways might a company use restricted stock awards?

(9.15) A company might use restricted stock awards as: 1. A front-end bonus to attract a top executive 2. A way to tie payment to book value, thus avoiding the market swings of publicly traded stock (this is for a private company) 3. A way to increase growth for a company in the mature stage of the market cycle 4. A form of golden handcuffs

What is a restricted stock award?

(9.15) A restricted stock award is a conditional transfer of company stock to an executive.

What term describes stock with lengthy periods of restriction?

(9.15) Career-restricted stock

What term describes a conditional transfer of company stock to an executive?

(9.15) Restricted stock award

What three things can't an executive do with a restricted stock award to avoid incurring a tax liability?

(9.15) The individual is prevented from assigning, selling or transferring the stock

What happens if an individual terminates employment before the restriction period of a restricted stock lapses?

(9.15) The stock is forfeited; however, in some cases (e.g., retirement, disability or death) the company may waive the forfeiture.

What type of stock award "plan" don't shareholders like, because they lack a performance feature?

(9.16) Fixed number of shares to be received at a specified date

What two names are given to fixed number of shares to be received at a variable date for restricted stock awards?

(9.17) 1. Performance-accelerated restricted stock plan 2. Time-accelerated restricted stock plan

What two laws must the company consider when using career stocks, because they may be viewed as deferred compensation?

(9.17) Because career stock may be viewed as deferred compensation: 1. IRC Section 409A may apply 2. The individual may be in constructive receipt of stocks

What term describes stock shares that cannot be sold while the individual is employed with the company?

(9.17) Career stock

What is career stock?

(9.17) Career stock is stock shares that cannot be sold while the individual is employed with the company.

What are three advantages of using a consecutive three-year plan to pay out a variable number of shares on a fixed date?

(9.18) 1. Annual adjustments (i.e., payouts) are made 2. Retention is increased since portions of two awards are always outstanding 3. Payouts are smoothed from year to year

Is it likely or unlikely that business journals will add performance share plan annual payments to salary and short-term incentive payments in reporting annual compensation?

(9.18) It is unlikely that business journals will add performance share plan annual payments to salary and short-term incentive payments in reporting annual compensation.

How is the number of shares to be received under a performance share plan calculated?

(9.18) Number of shares = function of (compound growth in earnings per share / time period)

What name is given to variable number shares and fixed date in terms of restricted stock awards?

(9.18) Performance share plan

Which of the following plans is most complicated? A. Fixed number of shares, fixed date B. Fixed number of shares, variable date C. Variable number of shares, fixed date D. Variable number of shares, variable date E. None of the above

(9.19) D. Variable number of shares, variable date

What is a nonstatutory stock option?

(9.2) A nonstatutory stock option is a stock option that fails to meet the requirements of a statutory option and, therefore, is more flexible in terms of grant size, ability to exercise, length of grant and holding period.

Does the TPI apply at time of exercise for nonstatutory stock options?

(9.2) No

Is there a tax liability at the time of grant for nonstatutory stock options?

(9.2) No

What is the most common form of nonstatutory stock option?

(9.2) Nondiscounted, 10-year grant

What term describes a stock option that fails to meet the requirements of a statutory option and therefore is more flexible in terms of grant size, ability to exercise, length of grant and holding period?

(9.2) Nonstatutory stock option

Is the capital gain on a nonstatutory stock taxed when sold?

(9.2) Yes, any capital gain is subject to the AMT.

Is there a tax liability at the time of exercise for nonstatutory stock option?

(9.2) Yes, the spread between market value and option price is considered taxable income.

What term describes stock of the parent company that is linked to or tracks the performance of a business unit within the company?

(9.20) Tracking stock (i.e., letter stock, target stock)

What type of stock is an alternative to a spin-off of a subsidiary or created at time of acquisition of a business?

(9.20) Tracking stock (i.e., letter stock, target stock)

What is tracking stock (i.e., letter stock or target stock)?

(9.20) Tracking stock is stock of the parent company that is linked to or tracks the performance of a business unit within the company.

Tracking stock is also used for stock awards and stock options for a unit's ______ executives.

(9.20) key

For what three reasons have shareholders been accepting of stock options as forms of incentives?

(9.3) 1. The executive must put up some of his/her own money. 2. The value is at risk with the price of company stock. 3. Assuming no discount, there is no charge to corporate earnings.

Historically, stock prices (decrease/increase) dramatically in the days and weeks preceding an initial public offering (IPO).

(9.3) increase

What is a stock appreciation right (SAR)?

(9.4) A stock appreciation right (SAR) permits the optionee to receive the appreciation of fair market value over option price in stock and/or cash without providing funds to pay the option price.

What term describes the permission for an optionee to receive the appreciation of fair market value over option price in stock and/or cash without providing funds to pay the option price?

(9.4) Stock appreciation right (SAR)

What is a freestanding stock appreciation right?

(9.5) A freestanding SAR is not connected in any way to a stock option.

What is a limited grant of a stock appreciation right?

(9.5) A limited stock appreciation right is one that is in effect only under specified circumstances.

What is a parallel grant of a stock appreciation right?

(9.5) A parallel grant would mean the stock option and stock appreciation right are independent of each other.

What is a tandem grant of a stock appreciation right?

(9.5) A tandem grant would mean the exercise of a stock option would proportionately reduce the stock appreciation right or vice versa.

Must stock appreciation rights always be connected to a stock option?

(9.5) No

What is an additive grant of a stock appreciation right?

(9.5) Under an additive grant, for example, the exercise of 4,000 options would automatically result in the additional payment of 4,000 stock appreciation rights.

Self-standing or freestanding stock appreciation rights are really ______ awards, since there is no accompanying stock option.

(9.5) phantom

Which Financial Accounting Standards Board (FASB) Interpretation Number requires that when stock or cash is available under payout, it will be assumed to be stock unless there is a reasonable basis for assuming otherwise?

(9.6) Financial Accounting Standards Board (FASB) Interpretation Number 31

What does Financial Accounting Standards Board (FASB) Interpretation Number 31 state?

(9.6) Financial Accounting Standards Board (FASB) Interpretation Number 31 requires that when stock or cash is available under payout, it will be assumed to be stock unless there is a reasonable basis for assuming otherwise.

The stock appreciation right is typically attached to the stock option at time of ______.

(9.6) grant

At what time do most people exercise a stock appreciation right?

(9.7) The most common approach during the exercise period is to make the stock appreciation right exercisable at the same time as the underlying stock option.

Which of the following would result in a tax deduction to the organization? I. Cashless exercise II. Stock appreciation right III. Stock-for-stock exchange

(9.8) I. Cashless exercise II. Stock appreciation right III. Stock-for-stock exchange

Which of the following would result in a charge to corporate earnings? I. Cashless exercise II. Stock appreciation right III. Stock-for-stock exchange

(9.8) II. Stock appreciation right

In what two unique situations are stock appreciation rights used?

(9.8) Stock appreciation rights are used when: 1. The country in which the optionee resides imposes high taxes and/or prohibits holding the security of a foreign country or purchase those shares. 2. There is a change of control of the company.

Stock appreciation rights waned with the spread of what two exercise methods?

(9.8) Stock-for-stock and cashless exercise of stock options (This occurred because the executive ended up with the same number of shares or cash equivalent that would have been received through exercise of the SAR.)

What typically occurs to stock option appreciation rights when a company changes control?

(9.8) The stock option appreciation rights vest at 100 percent and are automatically paid in the form of stock appreciation rights.

Stock appreciation rights are most attractive in times of (high/low)-interest rates and (high/low) stock price appreciation.

(9.8) high, low

How long does a stock option period typically last?

(9.9) 10 years

Which has a more limited period in which executives may decide whether or not to buy stock: stock options or an executive stock purchase plan?

(9.9) Executive stock purchase plan

How long does a stock purchase plan period typically last?

(9.9) One to two months