Modification to In-Flight Performance Share Awards Accounting and Disclosure Implications
Published October 13, 2020
Published October 13, 2020
Companies considering adjustments to in-flight performance share awards as a result of COVID-19 must consider accounting and disclosure implications of a modification to the awards.
As a resource, we outlined some of the disclosure requirements, as well as formulas for incremental expense values for four major types of performance share modifications.
Modifications to the goals for in-flight performance share awards require additional disclosure and incur additional accounting expense if the goals are modified from an award that is unlikely to be earned to an award that is likely to be earned, or to be earned at a higher level following the modification1
Summary of Modifications to Performance Share Awards
In certain circumstances, some adjustments are applied without requiring a modification
If the terms of the award agreement prescribes an adjustment (“shall adjust” and not “may adjust”), it is not considered a modification for these purposes (e.g., adjustments related to changes to accounting standards)
The distinction is that “shall adjust” ties directly to the goal measurement already in-use in the program (e.g., adjusted metrics), whereas “may adjust” implies after-the-fact discretion to adjust certain items that may not be covered in adjusted metric definitions. This distinction is a “fine-line,” thus we recommend reviewing actions against agreements and discussing adjustments with counsel and accountants.
If a modification does apply, the amount of the additional expense is based on the stock price at the time of the modification multiplied by the number of additional shares expected to vest after the modification
Expense is recognized over the remaining period of the award
Incremental value of the award is disclosed as a new grant in the Summary Compensation Table and the Grants of Plan-Based Awards Table
1 Award modification could also result in new cumulative accounting based on the modification share price even if an incremental cost is not recognized at modification. This cumulative expense would be based on the number of shares ultimately earned.
Performance Share Modification Accounting
A change to the terms and conditions of a share-based award must be accounted for as a modification if the change:
Affects any of the valuation inputs used to value the award,
Changes the vesting conditions, or
Changes the classification (as equity or liability) of the award
Is not prescribed by language in the award agreement (e.g., a provision that requires an adjustment for unusual events)
There are two primary variables that impact a modification accounting expense on the date of the modification: the then-current share price and the probability of award achievement.
Note that the probability of award achievement should be considered at all points on a potential payout curve (i.e., threshold, target, and maximum)— and that “probable” is more than 50% likely (whether 51% or 100%)2
If a modification produces an incremental accounting expense, then the value of the additional expense is recognized over the remaining service period.
The full incremental value of the modified award will appear in the Grants of Plan-Based Awards Table and Summary Compensation Table for any Named Executive Officers. Disclosure in these tables is required only to the extent that an incremental expense exists at the time of modification
For performance shares, there are four general types of modifications to think about. For simplicity, the following assume that there is only one goal (i.e., either all or none of the shares will be earned) rather than separate threshold, target, and maximum goals:
Type of Modification
FORMULA TO DETERMINE INCREMENTAL VALUE
Probable Achievement to Probable Achievement
Adjusting goals such that achievement of the goal remains probable, but easier to achieve
(current stock price * number of shares expected post-modification) – Minus – (current stock price * number of shares expected pre-modification)
In our case (only one goal) there is no initial incremental expense. If the now lower goal is met, the cumulative expense is still based on the original grant date fair value even if the original goal is not met (as the original goal was probable at the time of the modification)
Probable Achievement to Improbable Achievement
Adjusting goals such that achievement of the goal changes from Probable to Improbable (a rare situation) results in no incremental expense
Using the above formula, there is no incremental expense
Cumulative expense is based on original grant date fair value and is recognized so long as the original goal is met (regardless of whether the modified goal is met.)
Improbable Achievement to Probable Achievement
Adjusting goals from Improbable achievement to Probable achievement will inherently have a modification expense since Improbable implies an accrual of 0%; however, the magnitude of the modification expense will hinge upon stock price at the time of the modification and the level of the Probable goal achievement
Incremental expense is determined using the above formula; effectively, the incremental cost will be equal to the stock price at the time of the modification (regardless of whether higher or lower than the stock price on the grant date) times the number of shares expected to vest under the modified goal The cumulative expense is based on the stock price at the time of the modification times the number of shares that actually vest
Improbable Achievement to Improbable Achievement
Adjusting goals from Improbable achievement to Improbable achievement means that no incremental expense is recognized on the modification date; if expected achievement moves to Probable in the future, then the fair value on the date of the modification would be used for the accrual
Using the above formula, there is no incremental expense
The cumulative expense, to the extent that shares are ultimately earned, is based on the stock price at the time of the modification times the number of shares that actually vest— but does not have a disclosable incremental cost at the time of modification
NOTE: For awards subject to market conditions (e.g., absolute or relative TSR), the same basic fair value analytical framework applies, except that there is no estimation of the shares expected to vest—meaning the formula is the fair value of the awards post-modification minus the fair value of the awards just prior to the modification. The original grant date fair value and any incremental cost is recognized so long as the service condition is met, regardless of whether the market condition is met.
2 The probable/ improbable analysis needs to be applied to the various payout points. For example, achievement of a pre-modified target may be improbable, while the achievement of the threshold goal for the same award may be probable. A modification of this grant could result in threshold and target being probable.
Blair Jones has 30 years of executive compensation consulting experience. She has worked extensively across industries and has deep expertise in advising boards on company transitions, significant investor concerns, and an expanding human capital management mandate. Before joining Semler Brossy, Blair was the practice leader in Leadership Performance and Rewards at Sibson and an Associate Consultant at Bain & Company.
Blair holds the designations of Certified Benefits Professional (CBP), Certified Compensation Professional (CCP), and Certified Executive Compensation Professional (CECP). Blair has been named to the D100, NACD Directorship Magazine’s annual list of the most influential people in the boardroom for 10 consecutive years (2013–2022). Blair serves on the Mohawk Valley Healthcare System’s foundation board and is the Women’s Giving Circle leader. She also serves on the advisory board for M3 Placement & Partnership.
Named to the D100, NACD Directorship Magazine’s annual list of the most influential people in the boardroom community, including directors, corporate governance experts, regulators, and advisors, for eight consecutive years (2013–2020).
Doug Tormey is our lead technical advisor providing expertise on tax, legal, and accounting issues, particularly in mergers, acquisitions, divestitures, and buy-outs. He is a frequent lecturer and author, including contributions to ERISA and Benefits Law Journal and Compensation & Benefits Management. Doug received his JD degree from Hofstra Law School and a BA degree from Fordham University.