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Stock-based compensation - 5 things to know about modifications · PwC's accounting podcast

• 0:00
  SPEAKER_02: Flip leadership from PwC's National Office.
• 0:06
  SPEAKER_01: Hello, and welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_01: I'm Heather Horn.
• 0:12
  SPEAKER_01: Today we kick off our next two-episode series with topics from our stock-based compensation guide.
• 0:18
  SPEAKER_01: In today's episode, we focus on modifications of stock comp awards, which is one of the most popular topics from the guide.
• 0:26
  SPEAKER_01: And we're switching things up for this series and returning to one of our tried and trued approaches where we focus on the top five things you need to know about a topic.
• 0:35
  SPEAKER_00: One of the reasons it's hard for practitioners is because they might deal in uh stock compensation accounting frequently because they're dealing with the annual grants that are being made or the new hire grants that are being made.
• 0:47
  SPEAKER_00: So like the steady-state accounting, they understand it, but they don't uh encounter modifications as often.
• 0:53
  SPEAKER_00: And so that is why it makes it a little trickier because they just don't deal in that part of the literature as much.
• 0:59
  SPEAKER_01: That was Ken Stoller, a partner in PwC's national office who specializes in financial reporting topics related to equity compensation arrangements, retirement and healthcare plans, and other benefits.
• 1:10
  SPEAKER_01: I'm excited to have him on today to discuss this topic.
• 1:14
  SPEAKER_01: So let's start the episode.
• 1:20
  SPEAKER_01: Ken, welcome back to the podcast.
• 1:22
  SPEAKER_01: So nice to have you on today.
• 1:23
  SPEAKER_01: And as our regular listeners know, this year has been all about covering some of our most popular guides, and stock comp is among those.
• 1:32
  SPEAKER_01: So happy to have you on.
• 1:33
  SPEAKER_01: Thank you.
• 1:33
  SPEAKER_01: And today we'll be talking about stock-based compensation modifications.
• 1:38
  SPEAKER_01: And to change up the format for these next two, covering both stock comp guide, we're going to focus on these five things you need to know.
• 1:46
  SPEAKER_01: So before you dive into your top five things about stock comp modifications, why did you pick modifications of all the topics?
• 1:55
  SPEAKER_00: So in the stock compensation space, modifications tends to be the most common area that we get consultations in the national office.
• 2:06
  SPEAKER_00: And I think that's in part because it's a complicated area, as we're going to talk about today.
• 2:12
  SPEAKER_00: And there's just so many reasons companies make modifications, whether it's changing performance targets because operations have been better or worse than expected, or changing market conditions because the stock price hasn't done what we thought it would do, or we've got some corporate transaction like a business combination or a stock split or a spin-off.
• 2:32
  SPEAKER_00: So many different reasons for modifications.
• 2:35
  SPEAKER_00: Complicated area.
• 2:36
  SPEAKER_00: That's my top five list.
• 2:38
  SPEAKER_01: All right, very good.
• 2:39
  SPEAKER_01: So what's the the first thing you would uh say is the the number one thing people should think about with stock modifications.
• 2:47
  SPEAKER_00: All right.
• 2:47
  SPEAKER_00: So number one is is it even an accounting modification?
• 2:52
  SPEAKER_00: Because the guidance acknowledges that uh companies might make changes to their plans that are more administrative in nature and don't necessarily require us to go through the whole modification accounting model that we're going to talk about here.
• 3:07
  SPEAKER_00: So the first step is always uh to think about three criteria that are listed, which if you meet any of the three criteria, it is a modification and we should run it through the accounting model.
• 3:21
  SPEAKER_00: But if you don't take any of these boxes, then we can stop right there.
• 3:25
  SPEAKER_00: Uh so the first is does the change have any impact on the fair value?
• 3:30
  SPEAKER_00: Does the change have any impact on the vesting conditions?
• 3:34
  SPEAKER_00: Or does the change have any impact on the classification, equity versus liability?
• 3:40
  SPEAKER_00: So if the change we've made impacts any of those three things, we'll continue on, it's a modification for accounting, and vice versa.
• 3:47
  SPEAKER_01: So Ken, let me ask a follow-up question on that, because uh you said that so you there it sounds like there's a presumption often that people say, Well, I made a change, it must be modification.
• 3:58
  SPEAKER_01: And you're saying, no, that's not really the case.
• 4:00
  SPEAKER_01: But once someone gets into it and actually starts to evaluate, does it meet the criteria for modification?
• 4:06
  SPEAKER_01: Is there much judgment there typically, or it's more, you just need to make sure you ask this question and look at it?
• 4:13
  SPEAKER_00: I think sometimes it's clearly just administrative and then it's pretty easy.
• 4:16
  SPEAKER_00: It's not affecting the fair value, it's not affecting the classification, et cetera.
• 4:20
  SPEAKER_00: Sometimes there's a little more judgment.
• 4:21
  SPEAKER_00: One example, which I know you've talked about on previous podcasts, is related to uh the SEC has some new rules on clawbacks that came out recently.
• 4:28
  SPEAKER_00: So some companies are having to put new clawback provisions into their plans.
• 4:33
  SPEAKER_00: That seems like it might have an impact on the value of the arrangement.
• 4:37
  SPEAKER_00: And we've now added a new clawback feature.
• 4:40
  SPEAKER_00: But the way we value awards for stock com purposes is we explicitly exclude any clawback provisions when we're thinking about the value of an arrangement.
• 4:51
  SPEAKER_00: So in that situation, even though we're adding a clawback provision, it would not tick any of the three boxes here, and therefore we wouldn't have to run it through the modification accounting model.
• 5:00
  SPEAKER_01: All right, very interesting.
• 5:01
  SPEAKER_01: So then let's assume that we do uh meet the criteria and we do have a modification.
• 5:07
  SPEAKER_01: Then what's sort of the next thing that the listeners should think about?
• 5:11
  SPEAKER_00: So number two is going to be the overall modification framework, the overall principles before we start getting into some of the nitty-gritty.
• 5:20
  SPEAKER_00: So think about a modification as effectively exchanging the original award for a new one.
• 5:29
  SPEAKER_00: And in that exchange, is the new award more valuable than the one that was given up?
• 5:36
  SPEAKER_00: If it is, then we've clearly given the employee some additional compensation and we're gonna have to recognize that.
• 5:42
  SPEAKER_00: We call that additional amount incremental value.
• 5:45
  SPEAKER_00: If there is incremental value in the modification, then there's gonna be additional compensation.
• 5:50
  SPEAKER_00: And when we're determining whether there's incremental value, we're going to look at the value of the new award compared to the value of the original award immediately before we made the change, so that we can kind of isolate what was the increased value that we provided to the employee.
• 6:09
  SPEAKER_00: And then if there is incremental value, then we're going to tack that on to whatever the original value of the award was that we've been recognizing, and we'll recognize that over the remaining testing period.
• 6:22
  SPEAKER_01: So just to confirm then, so the incremental value is really the comparison immediately before and immediately after.
• 6:29
  SPEAKER_01: It's not, you know, when you decide to do the accounting, or there's all different times people can look at this.
• 6:35
  SPEAKER_00: Uh I'm glad you raised that because that maybe is the first red flag that I'll point out of maybe many that are going to come in this podcast, which is some companies that I'm talking to when dealing with modification uh assume that we're comparing the value of the new arrangement today to the original grant date value from you know two years ago when we granted the award.
• 6:57
  SPEAKER_00: So for example, maybe the original grant value was 100 bucks, the value immediately before the modification has risen to maybe 150, the value of the new thing is 160.
• 7:08
  SPEAKER_00: Well, some inappropriately assume we're comparing that 160 value today to the original hundred and that there's sixty dollars of increased value.
• 7:17
  SPEAKER_00: That's not the way we think about it.
• 7:18
  SPEAKER_00: It's just the value immediately before the 150 compared to the 160 now,$10 of incremental value.
• 7:25
  SPEAKER_01: And then this is presuming that there's an increase in value, but do we see cases where there's decreases in value as well?
• 7:32
  SPEAKER_00: We do.
• 7:33
  SPEAKER_00: Good point.
• 7:34
  SPEAKER_00: And we ignore.
• 7:35
  SPEAKER_00: Oh.
• 7:36
  SPEAKER_00: So for equity classified awards, if the value had gone from 150 down to 140, we don't get to reverse some of the expense we were going to recognize.
• 7:47
  SPEAKER_00: We simply ignore it and we continue recognizing whatever that original value was that we had been recognizing.
• 7:54
  SPEAKER_01: And when this is going to test maybe your memory, but when they were developing these models, then why did they do this sort of asymmetrical model?
• 8:03
  SPEAKER_00: Well, I think that, and we'll we'll see this as we continue in the in the podcast here.
• 8:07
  SPEAKER_00: There are a variety of anti-abuse provisions.
• 8:11
  SPEAKER_00: Uh, and this I think is an element where clearly, if we're giving an employee additional value, we want to recognize that it's additional cost.
• 8:18
  SPEAKER_00: But we didn't want companies to have the opportunity to make some modification that decreases the value of the thing, and then we can reverse some of the expense that we were going to recognize.
• 8:28
  SPEAKER_01: Okay, that definitely makes sense.
• 8:29
  SPEAKER_01: So then I know that this all sounds fairly straightforward, but it definitely gets fairly tricky fairly uh quickly.
• 8:38
  SPEAKER_01: So, what then would you focus on next?
• 8:40
  SPEAKER_00: Okay.
• 8:40
  SPEAKER_00: So now we'll start getting into the details a bit more with number three, which is the four types of modifications.
• 8:48
  SPEAKER_00: Uh listeners are probably aware that anytime we've got an award with a service condition or a performance condition, we assess the probability of those conditions.
• 9:00
  SPEAKER_00: And we have to do that when we've got a modification.
• 9:03
  SPEAKER_00: So we'll start with a type one modification.
• 9:06
  SPEAKER_00: That's a probable to probable modification.
• 9:09
  SPEAKER_00: So that means immediately before the modification, the award was probable of vesting.
• 9:14
  SPEAKER_00: Immediately after, it's still probable of vesting.
• 9:17
  SPEAKER_00: Easy example of that might be a plain vanilla stock option.
• 9:21
  SPEAKER_00: It just had a three-year service requirement.
• 9:25
  SPEAKER_00: We're two years in, we make a modification.
• 9:27
  SPEAKER_00: Maybe we're going to drop the exercise price from$10 down to$6.
• 9:33
  SPEAKER_00: Uh that doesn't have any impact on the probability of vesting, that change.
• 9:38
  SPEAKER_00: So it's probable before, it's probable after.
• 9:41
  SPEAKER_00: And so in a type one, all we're doing is recognizing or calculating what that incremental value is that we discussed earlier.
• 9:50
  SPEAKER_00: There clearly will be some incremental value.
• 9:51
  SPEAKER_00: We've increased the value of this option.
• 9:54
  SPEAKER_00: So we'll calculate whatever that incremental value is, and then we will recognize that over the remaining service period.
• 10:01
  SPEAKER_00: And maybe an additional red flag to watch out for here.
• 10:05
  SPEAKER_00: There's also sometimes a misconception when we calculate this incremental value, because in this example we were two years into a three-year service period, that we should catch up to two-thirds of that incremental value.
• 10:18
  SPEAKER_00: That is not the model.
• 10:19
  SPEAKER_00: We recognize it prospectively only.
• 10:23
  SPEAKER_00: And I think about it as the incremental value is uh a new uh element of compensation that is being given to the employee.
• 10:32
  SPEAKER_00: So it's not for any past service that the employee has performed, it's purely for service in the future, and that's why any of this incremental from these modifications is only recognized prospectively.
• 10:45
  SPEAKER_01: All right, makes sense.
• 10:46
  SPEAKER_00: Yep.
• 10:46
  SPEAKER_00: And so now we'll move into type two, far less common than a type one.
• 10:52
  SPEAKER_00: This is a probable to improbable.
• 10:56
  SPEAKER_00: So uh, and you can you can envision why it wouldn't be terribly common, right?
• 11:00
  SPEAKER_00: We had an award, it was probable of vesting, now we're gonna make some modification to it, and now it's no longer probable of vesting.
• 11:07
  SPEAKER_00: Employees probably not gonna be thrilled that we're doing that to the award.
• 11:12
  SPEAKER_00: Uh so most companies would be hesitant to make a change like that.
• 11:15
  SPEAKER_00: But where we do see it is sometimes there will be a give and take in the modification.
• 11:21
  SPEAKER_00: Maybe there's more than one modification happening.
• 11:23
  SPEAKER_00: So, for example, maybe we had a stock option that just had a service requirement, so it was probable investing, but it's now underwater.
• 11:32
  SPEAKER_00: It's now deep out of the money.
• 11:33
  SPEAKER_00: So the employee doesn't think they're ever going to get any value out of it.
• 11:38
  SPEAKER_00: So the company says, here's what we'll do: we'll modify the exercise price, we'll drop the exercise price down, which will make the option more valuable.
• 11:47
  SPEAKER_00: But at the same time, we're going to add a new performance condition that has to be met as well.
• 11:53
  SPEAKER_00: Maybe it's an IPO condition.
• 11:55
  SPEAKER_00: We have to have an IPO in order to vest.
• 11:58
  SPEAKER_00: That condition is not probable.
• 12:01
  SPEAKER_00: And so now the award is no longer probable of vesting.
• 12:04
  SPEAKER_00: The employees okay to take that exchange because at least if the uh if the option vs, it is now an option that won't be deep out of the money.
• 12:14
  SPEAKER_00: Um so in this situation, we would still calculate what the incremental value is because we reduced the exercise price, the value of the option has gone up.
• 12:25
  SPEAKER_00: But because the award is no longer probable, we'll just put that incremental value amount in our back pocket.
• 12:31
  SPEAKER_00: We're not going to do anything with it because the award is not probable.
• 12:34
  SPEAKER_00: But uh, and maybe this is the next red flag to watch out for, even though the award is not currently probable, we still have to continue recognizing the original grant date value.
• 12:47
  SPEAKER_00: This is another one of these anti-abuse provisions that's included.
• 12:51
  SPEAKER_00: Because normally, if an award's not probable, we're not recognizing any expense related to it.
• 12:57
  SPEAKER_00: Uh, but in this case, if we're modifying from probable to improbable, the FASB didn't want a company to be able to reverse all the expense simply by modifying and adding some condition that's not probable.
• 13:09
  SPEAKER_00: So they said, at a minimum, you need to continue recognizing that original value.
• 13:14
  SPEAKER_01: All right, let me ask a follow-up question.
• 13:15
  SPEAKER_01: I don't want to get us too sidetracked, but you caught my ear because you said that if they put, for example, a condition that there has to be an IPO, that would make it improbable.
• 13:25
  SPEAKER_01: And is that always the case?
• 13:27
  SPEAKER_01: So what if this was changed in the lead up to an IPO?
• 13:31
  SPEAKER_01: And so the company's saying, oh, we think we're gonna do an IPO.
• 13:35
  SPEAKER_01: So does would that make it probable?
• 13:37
  SPEAKER_01: Or is that always considered improbable because it's outside of their control?
• 13:41
  SPEAKER_00: That's correct.
• 13:43
  SPEAKER_00: Um, this is one area where a performance condition is not considered to be probable until it actually comes to fruition.
• 13:51
  SPEAKER_00: It's basically two examples IPO or a change of control condition.
• 13:54
  SPEAKER_00: And it's for the reason you said it's because it's not fully within the company's control.
• 13:58
  SPEAKER_00: And so we didn't want a company to be able to assess the probability of something that's not fully in their control.
• 14:03
  SPEAKER_01: Yep.
• 14:04
  SPEAKER_01: Okay, that definitely makes sense.
• 14:05
  SPEAKER_01: So then let's move on to type three.
• 14:07
  SPEAKER_01: And if I remember from our past conversations, this one works a little bit differently than the first two that we talked about.
• 14:13
  SPEAKER_00: Uh that's true.
• 14:15
  SPEAKER_00: So type three is improbable to probable.
• 14:19
  SPEAKER_00: So an example of this would be maybe we had an award that had a performance condition, maybe it was a revenue target, a million-dollar revenue target, uh, that wasn't considered probable of achieving, and so the award was not probable.
• 14:35
  SPEAKER_00: And now we modify the award and maybe we just eliminate that performance condition altogether.
• 14:41
  SPEAKER_00: So now the award is probable after the modification.
• 14:46
  SPEAKER_00: So in these type three situations, the guidance effectively views it as a brand new grant being made.
• 14:55
  SPEAKER_00: It's like the original thing was not going to vest anyway.
• 14:58
  SPEAKER_00: It was improbable.
• 15:00
  SPEAKER_00: And now we've just given a new arrangement that is probable.
• 15:04
  SPEAKER_00: So we throw away the original grant value.
• 15:07
  SPEAKER_00: It is no longer relevant if we have a type 3 modification.
• 15:11
  SPEAKER_00: And so we are simply measuring the value of the award today at the modification date, following our earlier example.
• 15:18
  SPEAKER_00: That's$160 today, even though the original grant value was$100.
• 15:22
  SPEAKER_00: The 160 is the new measure that gets fixed and is what is going to be expensed over the remaining service period.
• 15:30
  SPEAKER_00: And I'll add another red flag, which is there's no CUM catch here either.
• 15:36
  SPEAKER_00: And I see many who are kind of assuming, well, we're two years into the three-year arrangement.
• 15:41
  SPEAKER_00: We've modified the thing.
• 15:42
  SPEAKER_00: Yeah, we understand we have to remeasure and its value is 160 now.
• 15:45
  SPEAKER_00: So we'll catch up two-thirds of that 160 and then spread it on.
• 15:49
  SPEAKER_00: That is not the approach.
• 15:51
  SPEAKER_00: And again, it's because we view this to effectively be uh a brand new award that's being granted.
• 15:58
  SPEAKER_00: And so all of that expense will be recognized in the future.
• 16:01
  SPEAKER_01: So sorry, just to clarify then, and I'm sorry if you said this.
• 16:04
  SPEAKER_01: So you had this original one that was 100, now you have 160.
• 16:08
  SPEAKER_01: So obviously you've recognized some expense if you're two years of the way in for this original 100.
• 16:14
  SPEAKER_01: Do you take that into account, or you just say, nope, I have a new award that's 160, I have to recognize that all in this one year period?
• 16:21
  SPEAKER_00: So it so it depends.
• 16:23
  SPEAKER_00: In the example I gave, the original award was not probable.
• 16:28
  SPEAKER_00: We didn't think we were going to achieve that revenue target, and so we weren't recognizing any expense in the first place.
• 16:34
  SPEAKER_00: So at the time of the modification, we didn't have anything to reverse.
• 16:38
  SPEAKER_00: But I'm glad you bring it up because one of the other common examples of a type three that we see a lot is uh picture an employee is holding just a just a normal time-based award, uh, and they're two two years into the service requirement, and they decide they're gonna quit.
• 16:55
  SPEAKER_00: So the award had been probable, they had been recognizing expense, but now because they've decided that they're going to quit, uh, at that point the award becomes improbable because they're gonna forfeit the award.
• 17:07
  SPEAKER_00: So we would have to reverse the expense there.
• 17:10
  SPEAKER_00: And sometimes the company will decide to modify and accelerate the vesting and allow the person to keep it anyway, which is what makes it the type three, because it was improbable before, because we knew we were gonna forfeit the award.
• 17:21
  SPEAKER_00: Now we've made it probable because you're gonna vest.
• 17:24
  SPEAKER_00: Um and so in that situation, we would reverse the original expense, and now we would take this new measure of value, and that would be the new expense that we recognize.
• 17:32
  SPEAKER_01: All right, very helpful.
• 17:33
  SPEAKER_01: So then let's go to the last type, which if I'm keeping track of all the variations, would be improbable to improbable.
• 17:39
  SPEAKER_00: Exactly right.
• 17:40
  SPEAKER_00: That's type four, improbable to improbable.
• 17:42
  SPEAKER_00: Uh, this is another one that's not nearly as common as the type one and type three, but we do see um maybe one of the more common examples of a type four is picture uh in private companies, they will often tie their awards to an IPO, like we were talking about.
• 17:58
  SPEAKER_00: So if an award is tied to an IPO, it's not probable.
• 18:02
  SPEAKER_00: Then if we make any modification to the award while it's improbable, but the IPO condition still exists, then the award is still improbable.
• 18:11
  SPEAKER_00: So it is an improbable to improbable.
• 18:14
  SPEAKER_00: But there might be, well, because it is a type 4 similar to a type 3, since it was improbable before the modification, we treat it as if the original award just went away, and that we have a brand new award that's being granted today.
• 18:28
  SPEAKER_00: So forget about the original grant value, measure the new value today, and now that will be the measure of expense if and when the IPO condition comes to fruition.
• 18:39
  SPEAKER_01: All right.
• 18:40
  SPEAKER_01: So then those were all modifications that relate to vesting conditions, but then I know there's other types of modifications.
• 18:47
  SPEAKER_01: So what should companies focus on there?
• 18:50
  SPEAKER_00: So number four modifications that change classification.
• 18:56
  SPEAKER_00: Right.
• 18:56
  SPEAKER_00: So in 718, every award needs to be classified as either equity or liability.
• 19:03
  SPEAKER_00: Um won't go into details on how we determine those classifications.
• 19:07
  SPEAKER_00: But if we had, for example, well, we'll start with an equity to liability modification.
• 19:14
  SPEAKER_00: Sometimes uh that's a result of an explicit modification to the terms of an award.
• 19:19
  SPEAKER_00: For example, originally the term said we were gonna settle this in shares.
• 19:23
  SPEAKER_00: Now we modify the terms to say we're gonna settle it in cash because it's now gonna be settled in cash.
• 19:29
  SPEAKER_00: It's a liability.
• 19:30
  SPEAKER_00: So we would have to flip from equity to liability.
• 19:34
  SPEAKER_00: When we uh when we make that modification, we're gonna need to recognize the liability, and liabilities in 718 are at fair value.
• 19:42
  SPEAKER_00: They're on a mark-to-market basis.
• 19:44
  SPEAKER_00: So we're gonna need to recognize the liability at today's fair value, but the original award had been recognizing at that fixed grant date value.
• 19:53
  SPEAKER_00: So we're gonna have a cumulative catch-up adjustment and a mark-to-market adjustment to get us to the liability value.
• 20:01
  SPEAKER_00: But I will caution again, maybe another red flag.
• 20:04
  SPEAKER_00: Uh this is a one-way street.
• 20:08
  SPEAKER_00: If the fair value is lower than the original grant value today, right?
• 20:13
  SPEAKER_00: So maybe the original grant value was$100.
• 20:16
  SPEAKER_00: Today the stock price is only$80.
• 20:19
  SPEAKER_00: So we're gonna have to set up our liability based on the$80.
• 20:23
  SPEAKER_00: But we have to recognize, as I we call it the floor, we have to recognize at a minimum that original grant value of$100.
• 20:32
  SPEAKER_00: And this was another one of these anti-abuse provisions because the company, uh Fazby didn't want companies to be able to make a modification to flip to liability if the share price had come way down and then be able to take less expense than they would have originally.
• 20:46
  SPEAKER_00: So that's an equity to liability.
• 20:49
  SPEAKER_00: Liability to equity modification is more straightforward.
• 20:53
  SPEAKER_00: So picture we had a cash-settled arrangement originally, we had been marking it to market.
• 20:57
  SPEAKER_00: Now we decide it's going to be share settled.
• 21:00
  SPEAKER_00: So we convert it to equity.
• 21:02
  SPEAKER_00: We would simply take our last mark-to-market adjustment, fix the value at that point because it's now equity classified, and now that fixed value is what we'll recognize over the reigning service period, much more straightforward.
• 21:13
  SPEAKER_01: Yeah, it's interesting listening to this.
• 21:16
  SPEAKER_01: And I guess for someone who's only dealing with this infrequently, then it seems like, okay, look it up, see which model you're in, follow the model.
• 21:24
  SPEAKER_01: But if you, since you deal with this all the time, do you see this?
• 21:28
  SPEAKER_01: I'll call it like a framework that you can really understand sort of how it all, all the pieces fit together, or is it really more instructions?
• 21:36
  SPEAKER_00: Yeah, no, I I think uh I think it is a model and a framework that makes sense.
• 21:40
  SPEAKER_00: And like we talked about, it's like is there incremental value?
• 21:43
  SPEAKER_00: If so, we're gonna recognize it.
• 21:45
  SPEAKER_00: It's just that um there are various of these anti abuse provisions that had to be added in.
• 21:50
  SPEAKER_00: And so in those situations, it's not I wouldn't view it fully as a model because we have to have anti abuse provisions, because if it was a full model, you might say, well, since it's a liability, now We should just be marking it to whatever its value is.
• 22:02
  SPEAKER_00: So it's a combination of model and framework that makes sense coupled with some anti-abuse.
• 22:06
  SPEAKER_01: Yeah, so you can almost picture that you have this model, but then those kind of buffered by these anti-abuse provisions.
• 22:12
  SPEAKER_01: All right, that's helpful to kind of help think about it.
• 22:15
  SPEAKER_01: And then maybe last point is you also mentioned obviously you can change performance conditions.
• 22:21
  SPEAKER_01: So what are the nuances related to that?
• 22:24
  SPEAKER_00: All right.
• 22:24
  SPEAKER_00: So number five modifications to performance conditions.
• 22:27
  SPEAKER_00: So like we talked about earlier with the four types of modifications, we have to think about whether we've got type one, type two, type three, et cetera.
• 22:36
  SPEAKER_00: Um, one of the red flags that we see when dealing with modifications of performance awards, it's very common these days with performance awards that it's not an all or nothing where we've got a, you know, a million dollar revenue target.
• 22:51
  SPEAKER_00: If we achieve it, you'll earn your 100 shares.
• 22:53
  SPEAKER_00: If we don't, you'll get zero.
• 22:55
  SPEAKER_00: They tend to be sliding scale type arrangements where I say, I will give you a million, I will give you a hundred.
• 23:02
  SPEAKER_00: Don't get too excited.
• 23:04
  SPEAKER_00: I will give you a hundred shares uh based on this operating metric, but you can earn between zero and two hundred percent of those shares, depending on where we fall in a kind of a sliding scale.
• 23:17
  SPEAKER_00: So uh at the time we may maybe we've got the sliding scale performance condition, we decide we're going to make it easier.
• 23:25
  SPEAKER_00: Operations haven't been as good as we expected.
• 23:27
  SPEAKER_00: We're gonna make the whole sliding scale a bit easier.
• 23:30
  SPEAKER_00: So uh immediately before we made that change, maybe 75 of the shares were probable of vesting.
• 23:38
  SPEAKER_00: Uh after we make the change, maybe it's now up to 100 shares that are probable.
• 23:43
  SPEAKER_00: But the total max was still 200 shares that we could potentially could have vested in.
• 23:48
  SPEAKER_00: In this situation, we actually have uh more than one type of modification happening at the same time.
• 23:54
  SPEAKER_00: So picture for the first 75 shares, that's a type one because they were probable of vesting before and they still are.
• 24:03
  SPEAKER_00: For the next batch of 25 shares uh to get us up to the 100, they were not probable yesterday.
• 24:09
  SPEAKER_00: Today they are probable.
• 24:10
  SPEAKER_00: That's a type three modification.
• 24:13
  SPEAKER_00: And then for the final hundred shares, they were not probable yesterday, and they're still not probable today.
• 24:19
  SPEAKER_00: But we need to think of each of those buckets separately as a type one, a type three, and a type four.
• 24:24
  SPEAKER_00: That is something that is often overlooked when companies are modifying their performance conditions.
• 24:29
  SPEAKER_01: Honestly, a little complicated for people who haven't dealt with this before.
• 24:33
  SPEAKER_01: So I would imagine you got a lot of questions about that.
• 24:36
  SPEAKER_01: So those I know were your sort of top five type of modification issues, but I'm sure there are others.
• 24:42
  SPEAKER_01: So any others that you at least would like to highlight uh here on the podcast?
• 24:47
  SPEAKER_00: Yeah, that well, it's true.
• 24:48
  SPEAKER_00: There are so many different types of modifications that we see.
• 24:51
  SPEAKER_00: So maybe just uh to share a couple of examples without going into detail.
• 24:55
  SPEAKER_00: So companies might either extend a service requirement or shorten a service requirement.
• 25:02
  SPEAKER_00: They might uh modify market conditions related to their awards, they might add retirement eligibility provisions, they might add clawback provisions like we were talking about earlier, and then lots of different modifications when we have different types of corporate transactions like business combinations, stock splits, spinoffs, that kind of thing.
• 25:20
  SPEAKER_01: All right.
• 25:20
  SPEAKER_01: And then from your perspective, I know you got a lot of questions in this area.
• 25:24
  SPEAKER_01: Are there any of these, I know you called out a number of red flags, but are any of these maybe more common that they trip people up or that you see more examples of companies, I hate to say this, but getting it wrong?
• 25:38
  SPEAKER_00: Um Well, I think the last one we talked about with the sliding scale performance conditions is a real sleeper.
• 25:43
  SPEAKER_00: Um, a lot of a lot of companies, when they look at that, they're just because your mindset is is it a type one or a type three?
• 25:49
  SPEAKER_00: Or and so it's very easy to overlook that there could be multiple types.
• 25:53
  SPEAKER_01: All right.
• 25:53
  SPEAKER_01: And then what uh other advice do you have for anyone who is dealing with these with stock comp modifications?
• 26:00
  SPEAKER_00: I think it's one of the reasons it's hard for practitioners is because they might deal in uh stock compensation accounting frequently because they're dealing with the annual grants that are being made or the new higher grants that are being made.
• 26:13
  SPEAKER_00: So like the steady state accounting, they understand it, but they don't uh encounter modifications as often.
• 26:19
  SPEAKER_00: And so that is why it makes it a little trickier because they just don't deal in that part of the literature as much.
• 26:24
  SPEAKER_00: And so, you know, use your resources, use your auditor, ask, uh, make sure you're asking the questions and uh and we'll get it answered.
• 26:31
  SPEAKER_01: Yeah, it sounds so easy when you explain it.
• 26:32
  SPEAKER_01: And I know from dealing with it, it's just not.
• 26:35
  SPEAKER_01: So, other than uh asking questions, where in the guide should people go look for this?
• 26:40
  SPEAKER_00: Yep.
• 26:40
  SPEAKER_00: Chapter four in the stock comp guide is the is the source.
• 26:44
  SPEAKER_01: All right, perfect.
• 26:44
  SPEAKER_01: Well, as always, such a pleasure to talk to you.
• 26:46
  SPEAKER_01: Thanks so much for joining me.
• 26:47
  SPEAKER_00: Thanks, Heather.
• 26:49
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• 26:51
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• 27:11
  SPEAKER_01: From Thought Leadership at PWC, I'm Heather Horn.
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