Executive Option Plan

The Executive Option Plan (EOP) long-term incentive involves issuing call options over the unissued capital of the organisation to an executive, with the executive being entitled to exercise these options after satisfying performance hurdles.

The exercise price of the options is generally set at the shares' market price at the time the options are issued. The reward's value is then determined by the increase in the value of the organisation's shares over the exercise price. Should the value of the organisation's shares be less than the exercise price of the options, the executive receives no reward regardless of whether the performance hurdles are satisfied.

The OTA Executive Option Plan is designed to comply with Income Tax Assessment Act 1997 (ITAA), Subdivision 83A-C, which provides income taxation deferral for the participants in the plan. The income taxation treatment of the option benefit in the hands of the employee is determined by the terms and conditions of the Executive Option Plan Rules. There are a number of requirements. Briefly, the term of income taxation deferral is determined by the requirement for a "real risk" of forfeiture clause and can in certain circumstances be followed by an escrow period for a total of seven years.

Option rewards are particularly suited to organisations that are anticipating high annual growth rates, such as start-up organisations.

Organisations in the early stages of the business cycle utilise the EOP long-term incentive as an attraction for potential employees when the business is generally unable to pay significant cash-based remuneration. Mining, biotechnology and information technology organisations predominantly use the EOP as a long-term incentive. Organisations considering introducing an EOP should be aware of the incentive to increase the share price at the expense of dividends, and other capital management techniques encouraged by an EOP, e.g. share buybacks (see Executive Share Plan (with finance) as an alternative to the EOP).

The organisation will need to comply with disclosure requirements of both the Corporations Law and, if an Australian Stock Exchange listed organisation, the Australian Stock Exchange Listing Rules.

All expenses involved in the design and establishment of the EOP are tax expensed in the organisation. The organisation will be required to disclose the value of options granted to certain employees, and to expense the 'value' of the options in their profit and loss account.

The method for determining the value of the options issued to the EOP to be expensed in the organisation's profit and loss account is complex, and is outlined in Australian Accounting Standards Board Accounting Standard 2. However, in general this will involve the valuation of the options under a method such as the binomial method. The value is then adjusted by expectations dependent upon whether performance hurdles will be satisfied. The value is then apportioned to the period of the EOP, with annual adjustments for changes in expectations (see Valuation and Costing of Remuneration Strategies).

Should you require assistance with any aspect of an EOP, or wish to discuss what a reasonable valuation is, please contact OTA.