Option Scheme Design I

Nature

An employee or director may be granted the right to acquire shares at an option price during a fixed period.  If share prices rise, in tandem with the company’s, earnings and profitability, the option holder may exercise the option and realize a gain on the shares.  If the market value of the shares falls below the option price, the option has no value and will not be exercised.

Share option certificates may be issued. Generally options are not transferable or assignable.  Transmission on death may, of necessity, be permitted.

Share option schemes may be most appropriate for the most senior management as they will have a more direct impact on the share price and corporate value than middle management and below. Where the company already has a savings-related option scheme or profit-sharing scheme, it may be appropriate to establish an executive option scheme for a limited number of senior executives only.

The institutional and stock exchange requirements may limit the number of shares that may be available for the schemes.

Tax

Unapproved share option schemes may be established. They will not benefit from taxation relief applicable to the exercise of the option, but they do allow much greater flexibility in design.

In the absence of specific tax relief, the employee or director is taxable on free or discounted shares or rights to shares at his marginal rate.  In principle, tax is payable on gains arising on the grant of an option. However, provided that the option is exercisable or capable of being exercised within seven years, there is no taxable gain on the grant of the option.

The gain on the exercise of the option is, in principle, an emolument of employment and subject to income tax. It may qualify for tax relief in accordance with a number of types of approved share schemes.

Where there is a transfer, gains are potentially taxable as employee income.

Participation

Generally, eligibility for membership of share option schemes is limited to full-time directors and qualifying employees. Each must work at least a defined number of hours per week, generally at least 20 to 25 hours per week.

They must work for the company or be directors of the company that establishes the scheme. Alternatively, they may work for certain associated and participating companies (e.g., in a group).

Institutional guidelines recommend that a director or employee may participate only if he is required to devote substantially the whole of his time to the company’s or the related company’s business. It should not be possible to qualify under two separate schemes generally.

Eligible employees and directors are generally determined according to the relevant criteria. The entitlements will accord with personnel policies and business culture. Larger companies will usually have a remuneration committee for directors. They will select directors and determine the grant of options under the scheme.

Terms of Grant

The option scheme is generally embodied in a resolution of the directors setting out its terms and conditions.  Approval of the Revenue is required. Option schemes may  be established by way of deed, in order to remove issues regarding consideration.  The scheme may provide for an overall duration, commonly  seven to ten years.

Options are generally granted on terms that they are exercisable within a short period after the announcement of results, although this is not mandatory.  Institutional guidelines recommend a time frame for the grant and exercise of options.  Generally, the option should extend up to seven weeks after the publication of the results.

Stock exchange rules restrict dealings by directors of listed companies in shares and in share option.  Generally, this applies to a period of months prior to the publication of significant financial results whether annually or bi-annually.

Price Issues

Model schemes may provide that the applicant pays a nominal sum for the grant of the option. The price must be determined at the time of the grant. The rules may allow variation of the option price during the life of the option.  For example, the price may increase by specified fixed amounts, amounts linked to inflation or another index.

Under approved executive share option schemes, the price must be based on the market value of the shares during a certain time before the grant.  They are limits on the extent to which Revenue will permit the option  exercise price to be ascertained by reference to earlier prices.

The price must be not significantly less than the market price at the relevant time.  There may be provision for discounted price options which may be specifically approved. To the extent that a discount is afforded,  the undervalue is taxable as income.

Terms of Option

Generally, listed companies have a limit of four times earnings in terms of share value as a maximum. Taxation rules may cap the maximum benefit from options. The  market price may not exceed a certain multiple of  earnings or in other cases, a fixed maximum sum.

Institutional guidelines limit individual participation in executive schemes to four times annual emoluments for companies within the scheme.  There are some limited concessions and exemptions. Guidelines set limits on the number of shares which may participate in the scheme.

There is generally a maximum of between five and 10% of share capital of the company over a ten-year period.  There is exceptions for smaller companies. There is recommended flow rates over the period.

Exercise Period

Institutional guidelines historically require that options could not be exercised generally within three years of the grant.  There are exceptions for employees who leave early, particularly in case of involuntary departure.

Schemes, including unapproved schemes will generally provide that the option must be exercised within seven years or that is not capable of being exercised beyond seven years.  If this were to occur, there would be income tax on the grant of the option.

Terminati0n Issues

The guidelines contemplate exercise of options by former employees regardless of reasons for leaving. Institutional guidelines limit the period of exercise of the option to one year after termination of employment.

Most companies allow exercise, only in the case of involuntary circumstances such as redundancy, disability, injury, retirement with employers consent, cessation of employment with a participating company as a result of transfer of assets or sale of business.Schemes may allow the exercise of options after cessation of employment following maternity.

Exercise Conditions

The scheme may require that certain conditions to be fulfilled as a precondition of the exercise of the option. Institutional guidance recommends the linkage of share option schemes with performance.  They may be related to key corporate performance indicators.

Traditionally, performance has been linked to earnings per share growth. Other  share price benchmarks are often preferred as are appropriate to the particular company.

Revenue require that there must be objective guidelines in respect of the conditions.  These should be fairly related to the performance of the option holders’ job.  Directors may be given an element of discretion regarding a variation of the performance conditions, after approval of the scheme by the shareholders.

Revenue does not favour a variation of the performance targets while options subsist.  At the minimum, a mechanism for alteration of performance targets must be clearly set out in the scheme.  The alteration must not be so fundamental that so that it might substantially vary the terms scheme.

Company Law Issues

Options granted to executives which are not capable of being transferred are not subject to the Prospectus Directive.  A prospectus is not required for shares granted free of charge.  There is an exemption for offerings less than €100,000.

Under Companies Act, a director of an Irish registered company must notify the award of shares or share options within five business days.  He must also notify any assignment or termination of the interest or rights to shares, within five business days.  The company must maintain a register of ch notifications which are open for publication.

Where the company is discharging the cost of providing the shares, a shareholder’s resolution may be required under the Companies Act unless the value of shares is less than [ €65,000] or 10% of the relevant assets of the company.