When Should a Company Consider Restricted Stock Grants to Executives?

Stock GrantsRestricted stock grants (RSGs) are one of the most common forms of equity compensation in publicly traded companies.

More than two-thirds of large publicly traded companies and half of small companies use RSGs. Generally, restricted stock grants provide executives grants of shares of stock that are subject to forfeiture unless certain conditions are satisfied.  The shares become available to the executive as the restrictions lapse, typically upon the completion of a period of employment or the attainment of a company performance goal.

RSGs are most useful as a means to recognize individuals with unique skills and contributions who are not normally eligible to receive stock options, such as high-potential middle managers and professional employees. Additionally, a company with difficulty retaining or recruiting key contributors can used RSGs as a recruitment bonus.  RSGs are especially attractive to private companies because the transfer restrictions ensure that outsiders will not be able to acquire shares of the company’s stock.

What Are The Advantages of Restricted Stock Grants?

RSGs are a popular form of equity compensation because they have significant retention characteristics (i.e., executives want to stay with the company until the restrictions lapse) and the uncertainty of the stock market (i.e., the executive receives value even if the stock price remains level, or even if it goes down) does not affect the value of RSGs.

What are The Disadvantages of Restricted Stock Grants?

RSGs are often criticized as a “freebie” for management because most companies condition the vesting of the stock only on service and do not impose any additional performance requirements. Therefore, executives are rewarded even when there is no improvement in a company’s performance. Additionally, existing share value is diluted as a result of RSGs for which no purchase price, or only a nominal one, has been paid.

What is the Tax Treatment of Restricted Stock Grants?

The value of RSGs to an executive is taxable as ordinary income to the executive and deductible by the company in the year in which it is no longer subject to a substantial risk of forfeiture (i.e., upon vesting or when all restrictions lapse). Alternatively, the executive may elect to pay ordinary income at the time of grant and make an Internal Revenue Code (“Code”) Section 83(b) election. If an executive makes an 83(b) election, he or she will be taxed immediately on the fair market value of the restricted stock at the time of grant.  Dividends paid on the shares are normal dividend income, which is not subject to withholding and not deductible by the company. One disadvantage of a Code Section 83(b) election is that if an executive later forfeits the restricted stock, he or she will not be entitled to any refund of the taxes previously paid. However, he or she will be allowed to treat the forfeiture as a sale of the stock at a loss.

If the executive does not make an 83(b) election, dividends paid on restricted stock before the executive’s rights become substantially vested can be deducted by the company as a compensation expense.

This summary is intended to be informational and does not constitute legal advice. Hamby Benefits Law, LLC recommends that you consult with ERISA legal counsel to assist (i) in determining whether RSGs are the appropriate equity compensation for your company, and (ii) with drafting, implementation and administration of RSGs that comply with all necessary legal requirements.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.
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