CEP Equity Compensation Plans & Design 2 — Questions and Answers
Question 1: A company wants to provide equity awards that do not require employees to pay an exercise price. Which plan type best meets this objective?
- Incentive Stock Options
- Restricted Stock Units (RSUs) (Correct answer)
- Employee Stock Purchase Plan (ESPP)
- Non-Qualified Stock Options
Correct answer: Restricted Stock Units (RSUs)
RSUs deliver shares to employees upon vesting without requiring any purchase or exercise price.
Question 2: Under IRC Section 422, ISOs may only be granted to which category of individuals?
- Consultants and advisors
- Board members who are not employees
- Employees of the company or a qualifying subsidiary (Correct answer)
- Any service provider receiving compensation
Correct answer: Employees of the company or a qualifying subsidiary
ISOs are exclusively available to employees; consultants, directors, and other non-employees are ineligible.
Question 3: A plan provision that accelerates vesting of all outstanding awards upon a change in control is known as:
- Double-trigger acceleration
- Single-trigger acceleration (Correct answer)
- Cliff vesting
- Performance-based vesting
Correct answer: Single-trigger acceleration
Single-trigger acceleration causes vesting to speed up upon a change-in-control event alone, without requiring a second triggering event such as termination.
Question 4: What is the primary purpose of a 'liberal share counting' provision in an equity plan?
- To allow shares surrendered for tax withholding or exercise price to be returned to the plan reserve (Correct answer)
- To increase the total share authorization automatically each year
- To convert option shares to RSU shares at a higher ratio
- To exclude treasury shares from the plan's share pool calculation
Correct answer: To allow shares surrendered for tax withholding or exercise price to be returned to the plan reserve
Liberal share counting recycles shares used to pay taxes or the exercise price back into the plan reserve, extending the life of the share pool.
Question 5: Which of the following best describes a 'fungible share ratio' in an equity plan?
- The ratio at which fractional shares are rounded upon vesting
- The conversion rate applied when full-value awards reduce the plan's share reserve at a higher rate than options (Correct answer)
- The proportion of shares reserved for executive versus broad-based grants
- The ratio of outstanding shares to authorized shares under the plan
Correct answer: The conversion rate applied when full-value awards reduce the plan's share reserve at a higher rate than options
A fungible ratio (e.g., 1.5:1 or 2:1) causes each full-value share granted (RSU/restricted stock) to count as more than one share against the reserve, reflecting its higher value versus an option.
Question 6: A company grants stock options with a four-year graded vesting schedule (25% per year). An employee resigns after two years. What happens to the unvested portion?
- All unvested options immediately vest upon resignation
- The unvested options are forfeited and returned to the plan reserve (Correct answer)
- The unvested options remain outstanding until the original expiration date
- The unvested options convert to RSUs automatically
Correct answer: The unvested options are forfeited and returned to the plan reserve
Upon voluntary resignation, unvested awards are typically forfeited per plan terms and the shares revert to the plan reserve.
Question 7: Which plan design feature is most directly intended to align long-term executive interests with shareholder value creation?
- Providing cash dividend equivalents on unearned performance shares
- Setting performance goals tied to multi-year total shareholder return (TSR) (Correct answer)
- Granting options with a one-year vesting cliff
- Paying out awards in cash rather than shares to reduce dilution
Correct answer: Setting performance goals tied to multi-year total shareholder return (TSR)
Multi-year TSR-based performance goals directly tie payout to the stock price outcome experienced by shareholders over the same period.
CEP Equity Compensation Plans & Design 2
A company wants to provide equity awards that do not require employees to pay an exercise price.
Which plan type best meets this objective?