In the early 1990s the Financial Accounting Standards Board (FASB) established a standard (FAS 123) for equity based compensation. This ruling made the expensing of employee stock options in financial statements optional but required them to be footnoted. Fueled by the accounting and corporate governance scandals after the internet boom, FASB revised 123 to make "Fair Value" expensing of stock options mandatory. Implementation of this ruling begins June 15, 2005. Because of their heavy use of stock options as a compensation tool, the AeA (the leading trade association of technology firms) strongly opposes mandatory expensing claiming that it will seriously curtail operations and cut reported profits. Backed by the AeA, a bill (HR 3574) was passed by the House last July and referred to the Senate in September. If approved by the Senate, this bill would displace FAS 123(r) and require expensing of options granted to only the top 5 officers. There is a significant amount of both support and opposition in the Senate for this controversial bill, so only time will tell.

Another current equity compensation issue involves burn rates and dilution. The burn rate is the number of shares and options granted to employees in a single fiscal year expressed as a percentage of the total common shares outstanding (CSO). Dilution is the sum of the total amount of unvested shares and outstanding options, plus shares available for future grants, expressed as a percentage of total CSO. Company shareholders are pressuring management to reduce burn rates and dilution in order to maximize their return. Consequently some companies have begun to issue other forms of equity compensation such as restricted shares (RSPs), performance shares and stock appreciation rights (SARs). RSPs and performance shares can potentially reduce burn rates, dilution and expensing because they are granted in smaller quantities than options. However, these shares are not as effective as stock options in motivating and retaining employees when a company is growing. This is because equity shares offer downside protection but not the upside leverage of stock options.

Stock settled SARs are now being considered by many firms because they offer upside leverage with reduced dilution. Similar to a non-qualified stock option, Stock Appreciation Rights (SARs) are a right to receive compensation equal to the difference between the "grant price" and the fair market value at the time the right is exercised. The form of payment may be cash or securities. If the SAR is settled using company stock, it is called a stock-settled SAR and qualifies for preferential treatment under IRC 409A (the new deferred comp law).

The bottom line is that equity compensation plans are changing but not going away. A recent study by Watson Wyatt reported that companies are decreasing grants to employees in general but not necessarily to key executives. There are an estimated 500,000 executives with stock options and/or other forms of equity compensation. Additionally, the new forms of equity compensation complicate matters for these executives. Getting the most out of one's equity compensation, now more than ever, takes extensive knowledge and specialized analysis tools. Equity compensation planning is no longer something that can be effectively practiced by executives themselves or by financial advisors who are not highly skilled.