Tom Twitlet President Of Twitlet Corporation Is Considering

Tom Twitlet President Of Twitlet Corporation Is Considering Establis

Tom Twitlet, president of Twitlet Corporation, is considering establishing a compensatory share option plan for the company’s 20 top executives. He wants to set the terms so that the number of options exercisable increases based on specific increases in future earnings, ensuring the plan cannot be manipulated, while also motivating executives to stay and contribute to the company's success. He seeks guidance on whether the earnings increase should be defined in dollar amounts or percentage changes, and whether these should be compared to past company results or industry benchmarks. Additionally, he is interested in how to determine the service period tied to the plan and how the plan's terms will be reflected in the company's financial statements through proper accounting.

Paper For Above instruction

In designing a compensatory share option plan, several critical issues must be addressed to align executive incentives, prevent manipulation, and ensure accurate financial reporting. Central among these issues are the specification of performance metrics—particularly how earnings increases are defined and measured—the determination of service periods, and the accounting treatment of the plan.

Choosing Between Dollar Amounts and Percentage Changes

The first decision involves whether to use absolute dollar amounts or percentage changes in earnings as the basis for increasing options. Using dollar amounts may be straightforward but could be less flexible in reflecting relative improvements, especially for a growing company. Percentile-based metrics are often preferred because they normalize performance across different periods and are less susceptible to manipulation, especially if the goal is to reward relative improvement rather than absolute figures. According to stakeholder theory, incentive plans that link rewards to percentage improvements tend to better motivate executives to focus on overall company growth and efficiency (Eisenhardt, 1989). Moreover, percentage metrics enhance comparability over time and against industry benchmarks, making it more difficult to manipulate earnings through accounting adjustments that affect dollar figures less transparently.

Comparing Earnings: Past Results or Industry Benchmarks

Deciding whether to compare future earnings increases against the company’s past results or against industry benchmarks is crucial. Comparison with past results can motivate executives to consistently improve performance over historical levels but may encourage short-term gains at the expense of long-term value if not carefully structured. Conversely, benchmarking against industry results can align efforts with competitive standards, motivating executives to outperform peers. Research suggests that industry-relative performance targets are effective in fostering strategic improvement and market competitiveness (Jensen & Meckling, 1976). However, industry comparisons should be based on reliable and comparable data to prevent gaming the system or manipulating external benchmarks.

Determining the Service Period

The service period—the length of time over which performance is measured and restrictions apply—is vital in ensuring the plan retains an effective motivational horizon. Typically, service periods align with fiscal or calendar years, often spanning three to five years, to balance short-term motivation with longer-term strategic goals. The length should discourage premature cashing out and manipulation while fostering sustained effort. According to investment theories, longer service periods tend to reinforce commitment and align executive goals with long-term shareholder interests (Kaplan & Norton, 1992). The plan should specify what constitutes satisfactory performance within this period and what happens if the service period ends without the performance target being met.

Accounting for the Share Option Plan

From an accounting standpoint, share-based payment plans are governed by standards such as IFRS 2 (International Financial Reporting Standards) or ASC Topic 718 (Accounting Standards Codification) under US GAAP. These standards require companies to recognize compensation expense based on the fair value of the options granted at the grant date, amortized over the vesting period—often the service period in the plan. The fair value models, such as the Black-Scholes or binomial models, consider factors including stock price volatility, interest rates, dividend yields, and expected life of the options (Bailey et al., 2017). Proper accounting ensures transparency and comparability in financial statements, but it also impacts key metrics such as net income and earnings per share.

In particular, recognizing the expense at grant date does not depend on whether or not the options are ultimately exercised, but rather on the estimated fair value. Changes in the plan’s terms or in underlying assumptions may require restatement or remeasurement. Additionally, disclosures should include information about the plan’s fair value, the number of options granted, vesting conditions, and the expense recognized in each period, providing stakeholders with a comprehensive understanding of the plan’s financial impact.

In conclusion, the design of the share option plan involves careful selection of performance metrics—preferably percentage increases measured against industry benchmarks for better alignment and resistance to manipulation—and setting an appropriate service period to sustain motivation and commitment. Compliance with relevant accounting standards ensures accurate reflection of the plan’s cost, supporting transparency and stakeholder trust. By thoughtfully addressing these issues, Tom Twitlet can develop a plan that motivates executives, aligns their interests with the company’s success, and maintains financial integrity.

References

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• Financial Accounting Standards Board (FASB). (2018). ASC Topic 718: Compensation—Stock Compensation.
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