The Basics of Equity Compensation

Other vesting methods

There are other methods of vesting.

Accelerated vesting. Vesting acceleration may take place when a company is restructured, as part of a severance or employment agreement, or in the event an employee dies, is retirement eligible or becomes disabled. The conditions that trigger acceleration will be stipulated in the plan document.

Performance-based vesting. In this case, option vesting or vesting acceleration is dependent on the company attaining specific performance requirements by certain points in of time. Performance-based vesting is usually limited to senior executives and based on both individual and corporate targets.

Early exercise. Stock options may be exercised by a grantee before vesting is complete, grant conditions permitting. An early exercise may qualify for favorable tax treatment, such as avoiding short-term taxation and the alternative minimum tax (AMT). An early exercise does come with the risk that the shares may end up underwater and they have already been paid for.

Vesting Benefits Long-term Performance

Executive stock option grants have been criticized for creating a short-term success mindset among corporate leaders who have been accused of boosting company stock values at the expense of long-term company health. However, studies have shown that if done correctly, stock option grants can have a positive effect on long-term company performance. One way of ensuring that the focus is not just on quarterly results is to provide a plan where the options are vested in stages, such as 25% each year for four years. It is also possible to grant performance-vested stock options where vesting is based on reaching some performance goal and not a date. Of course, to ensure long-term performance, the goal has to be one of long-term success.