chief executive officer (CEO) means a person holding the position or office that is accepted legally or constructively to have the most authority within the reporting entity, whether or not subject to a governing body;
director means:
(a) a person who, regardless of the name that is given to the position, is appointed:
(i) to the position of a director; or
(ii) to the position of an alternate director and is acting in that capacity; or
(iii) in the case of entities governed by bodies not called a board of directors, to the position of member of the governing body, council, commission or authority;
(b) unless the contrary intention appears, a person who is not validly appointed as a director if:
(i) the person acts in the position of a director; or
(ii) the directors of the entity are accustomed to act in accordance with the person’s instructions or wishes (except where the directors act on advice given by the person in the proper performance of functions attaching to the person’s professional capacity, or the person’s business relationship with the directors or the entity);
disclosing entity is defined in the Corporations Act;
economic entity means a group of entities comprising the parent entity and each of its subsidiaries;
employee means a natural person (including a director) appointed or engaged under a contract for services who is subject to the direction of an employer in respect of the manner of execution of those services, whether on a full-time, part-time, permanent, casual or temporary basis;
equity compensation means employee benefits in the form of:
(a) equity instruments of the entity required to prepare the financial report or any of its subsidiaries; or
(b) rights to equity instruments that may, at the discretion of the entity, be settled either by cash payments or equity instruments of the entity required to prepare the financial report or any of its subsidiaries;
equity instrument means any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities;
executive means a person who is directly accountable and responsible for the strategic direction and operational management of the entity;
grant date means the date on which the entity and another party (including an employee) agree to the terms of a bonus or share-based payment compensation, being when the entity and the counterparty have a shared understanding of the terms and conditions of the grant. At grant date, the entity confers on the counterparty the right to cash (or other assets) or equity instruments of the entity on vesting date provided the specified conditions, if any, are met. If the grant is subject to an approval process (for example, by shareholders), grant date is the date when that approval is obtained;
long-term incentive plan means any plan or arrangement providing benefits, other than equity compensation, as an incentive for performance to occur over a period longer than one reporting period, whether such performance is measured by reference to the financial performance or share price of the reporting entity (or any of its subsidiaries) or any other measure;
parent entity means an entity which controls another entity;
personally-related entities means, in relation to a particular individual, the relatives of the individual, the spouses of the relatives and any other entity under the joint or several control or significant influence of the individual, relatives of the individual or spouses of relatives;
post-employment benefits means employee benefits (other than termination benefits and share-based payment compensation) that are payable after the completion of employment;
prescribed benefit means a benefit specified in the Corporations Act as requiring the approval of the shareholders or members of the corporate entity;
relative means, in relation to a person, the spouse, parent or remoter lineal ancestor, son, daughter or remoter issue, or brother or sister of the person;
repricing in relation to options or rights means any change to the terms or conditions of an option or right over shares or units that benefits the holder;
retirement means cessation of employment and includes loss of office, resignation and death at the time of holding that office;
retirement benefits means post-employment benefits other than pension, superannuation and termination benefits and includes prescribed benefits as well as benefits which, if earned progressively over the period of employment, are recognised on an accrual basis;
share-based payment compensation means, in respect of employees, benefits in the form of:
(a) equity compensation; or
(b) rights to equity instruments that may, at the discretion of the employee, be settled either by cash payments or the issue of equity instruments of the entity required to prepare the financial report or any of its subsidiaries; or
(c) other compensation, the amount of which depends on the future value of the equity instruments of the entity required to prepare the financial report or any of its subsidiaries;
specified director means a person who was, at any time during the reporting period, a director of the entity required to prepare the financial report;
specified executive means one of the five or more executives who:
(a) have the greatest authority for managing the economic entity or, where there are no subsidiaries, the entity required to prepare the financial report;
(b) are employed at any time during the reporting period by the entity or any of its subsidiaries; and
(c) are not specified directors;
subsidiary means an entity that is controlled by a parent entity;
termination benefits means employee benefits payable as a result of either:
(a) an entity’s decision to terminate an employee’s employment before the normal retirement date; or
(b) an employee’s decision to accept voluntary redundancy in exchange for those benefits;
vesting date means the date on which are satisfied the conditions precedent to an employee becoming beneficially entitled to the equity instrument or other bonus.
Specified Directors
12.1.1 The term director is defined to include any member of a governing board, body, council, authority or commission. It includes alternate directors as well as shadow directors (who acted in the capacity of director although not formally appointed as such). It also includes trustees and liquidators in relation to the entities they have responsibility for liquidating. The specified directors referred to in this Standard comprise all those who acted at any time during the reporting period as a director of the entity required to prepare the financial report.
12.1.2 When a disclosing entity is the parent entity in an economic entity, it is required by the Corporations Act to include in the financial report its own financial statements as well as consolidated financial statements (incorporating other entities that are its subsidiaries). Individuals who are directors of subsidiaries within an economic entity but not directors of the parent entity are not classified as specified directors.
12.1.3 Individuals who were directors during the reporting period but not at the reporting date of an entity required to prepare the financial report are classified as specified directors. The description of former specified director applies to those individuals who held the position of director in prior reporting periods and did not hold that position or did not act in that capacity at any time during the reporting period. This Standard does not include former specified directors in its disclosure requirements. Former specified directors are treated as related parties in respect of transactions with an entity that relate to their former position and that provide a benefit not included in remuneration previously disclosed. For example, benefits to be paid to a director who resigned from office during the current reporting period would be included in disclosure of the remuneration of the specified director (excluding accrued benefits disclosed previously as remuneration). Benefits paid in the current reporting period to a former specified director who resigned in an earlier reporting period are disclosed, not as remuneration under this Standard but in accordance with AASB 1017, unless the payment comprised only accrued benefits previously disclosed as remuneration.
Specified Executives
12.1.4 An executive is defined as a person who is directly accountable and responsible for the strategic direction and operational management of an entity. The specified executives comprise at least five executives with the greatest authority for managing the economic entity or, where applicable, the disclosing entity, other than those executives who are also directors of the parent entity (specified directors). They may be employed in the reporting period by the disclosing entity or by any of its subsidiaries within the economic entity. Where a disclosing entity is a parent entity, it is not required to specify five executives in respect of the parent entity and five executives employed by other entities within the economic entity.
12.1.5 The number of specified executives is stated as a minimum of five in the definition, to establish a base level and simultaneously enable entities to include more than five in the group if they wish. An entity may consider that its key management group includes more than five executives and it is more informative to include more individuals in the group of specified executives. Rather than eliminating candidates to arrive at a minimum of five specified executives, particularly when several candidates for the fifth place are equally qualified, the number in the group of specified executives is increased to the appropriate level. When the group of specified executives comprises more than five, the requirements of this Standard apply to all those in the group.
12.1.6 The level of remuneration can frequently be taken as indicating the degree of authority of an executive, but where there is reliable evidence that the authority within the economic entity of an executive at a lower level of remuneration is greater than the authority of an executive among the five most highly remunerated, then such an executive is included in addition to or instead of the higher-paid executive. Remuneration by itself does not form the basis for determining specified executives. For example, a currency trader who received high commissions but was not part of the key management team would not be classified as a specified executive of a financial institution even if the trader’s remuneration exceeded that of the CEO.
12.1.7 If a specified director is also an executive, this Standard requires that such a person be included only as a specified director. This means that executive directors of the parent entity are excluded when determining the specified executives. However, an executive who is also a director of a subsidiary of the parent entity is not excluded from being classified as a specified executive.
Vesting Date and Grant Date
12.1.8 The concept of vesting is relevant to many forms of employee benefits that are granted conditionally, whether cash or equity is involved. The conditions precedent, that must be satisfied before an employee becomes beneficially entitled, frequently refer to service conditions (relating to the services the employee provides to the entity) or performance conditions (relating to either the performance of the employee or the performance of the entity, however measured) or both service and performance conditions. The date on which the specified condition or conditions precedent are assessed as being satisfied is the vesting date. From that date, the employee’s right to receive or retain the benefits inherent in the cash or equity instruments granted is no longer contingent on the employee remaining in the service of the employer or on the achievement, by the employee or the entity, of a performance condition.
12.1.9 When an award of equity instruments is granted retrospectively as a reward for past services or performance, the recipient is usually unconditionally entitled to the beneficial interest in those equity instruments as from the grant date. In these circumstances, the grant date is the same as the vesting date.
12.1.10 When a contract with an employee states that the equity compensation or other bonus the employee may receive in the future will be at the discretion of the board of directors, the grant date will be the date on which the board exercises its discretion and not the date of the signing of the contract. In these circumstances, the grant date will only be the same as vesting date if the compensation granted by the board is not conditional on service or performance conditions being satisfied in the future.
Equity Compensation
12.2 All grants of equity compensation not fully vested before the start of the reporting period must be included in determining the amounts allocated to the remuneration of specified directors and specified executives disclosed for the reporting period, irrespective of when the grant was made.
12.2.1 When a grant of equity compensation to a specified person has not vested before the start of a reporting period, it is included in determining the amount of remuneration allocated to that person in accordance with the directions in Appendix 2 and the principles in Appendix 6. This applies only to persons who are specified for the reporting period and it applies irrespective of whether the person was specified in the period in which the grant was made.
12.2.2 Paragraph 12.2 does not apply to a person who is not a specified person in the current reporting period but was so classified in the reporting period in which the grant was made.
APPENDIX 1
GUIDANCE ON ITEMS INCLUDED IN REMUNERATION
The table below is based on Urgent Issues Group UIG Abstract 14 “Directors’ Remuneration” (June 1997) which provides guidance on items included in the remuneration of directors. All items identified in Column 1 of the Table are included when determining the amount of remuneration of a director or executive in accordance with paragraph 5.1 of this Standard. Column 1 is not necessarily exhaustive. Items shown in Column 2 are excluded from remuneration disclosed. An illustration of the classification of Column 1 items in accordance with the components prescribed in paragraph 5.2 is included in {parentheses} with the paragraph reference.
| COLUMN 1<br>Included in Remuneration | COLUMN 2<br>Excluded from Remuneration |
| Directors’ fees<br>{primary – fees 5.2(a)(i)} | Payments made to directors, executives or personally-related entities for consulting services not in connection with the management of the affairs of the entity or any subsidiary. These items are disclosed separately in accordance with the requirements relating to other transactions of directors and executives. |
| | The salary of an employee (not an executive) who is made a director during the reporting period; for the part of the reporting period when not a director |
| Allowances (other than payments or reimbursements of business expenses), including<br>club membership for the director or executive and members of their families except where the membership fees are business expenses<br>{primary – non-monetary 5.2(a)(iii)} | Reimbursements of out-of-pocket business expenses<br> <br>Club membership for the director or executive and members of their families where such membership is incurred for business purposes |
| Bonuses, profit share, commissions and incentive payments (to the extent determinable at the reporting date)<br>{primary – bonus 5.2(a)(ii)} | |
| Private assurance and insurance premiums paid in whole or part by the entity or related party, including life, accident, health and policies to indemnify directors or executives<br>{other benefits – 5.2(d)(ii)} | Workers’ compensation insurance<br>Life insurance on life of director or executive where the employer is the beneficiary<br>Key person insurance |
| Use of services or property of the entity for private purposes, including:<br>- use of a house;<br>- use of an office and secretarial services;<br>- use of other property, such as a company-owned holiday home<br>{primary – non-monetary 5.2(a)(iii)} | Telecommunication facilities and computers provided for use on entity-related matters, including such facilities installed in the home of a director or executive |
| Education fees for family members of the director or executive<br>{primary – non-monetary 5.2(a)(iii)} | |
| Expatriate package costs and domestic transfer equivalents, including housing subsidy, airfare entitlements, all allowances, utilities, tax return services and tax equalisation costs<br>{primary – non-monetary 5.2(a)(iii)} | Reimbursement of relocation costs, including stamp duty, removalist costs<br>Interest on bridging finance for relocation at request of the entity<br> |
| Fringe benefits tax on benefits provided<br>{primary – non-monetary 5.2(a)(iii)} | Payroll tax |
| Goods and services provided<br>{primary – non-monetary 5.2(a)(iii)} | |
| Leave entitlements, including:<br>- annual leave and leave loading;<br>- sick leave;<br>- long-service leave<br>{primary – salary 5.2(a)(i)} | |
| Low (and zero) interest loans by the entity or related party: interest foregone<br>{primary – non-monetary 5.2(a)(iii)} | |
| Motor vehicles for private use: expenses including running costs<br>{primary – non-monetary 5.2(a)(iii)} | |
| Personal expense payments, including medical and other private insurance, telephone and general household expenses<br>{primary – non-monetary 5.2(a)(iii)} | |
| Contributions to superannuation funds,<br>{post-employment – 5.2(b)(i) or (ii)}<br>and any other retirement benefits<br>{post-employment – 5.2(b)(i), (ii) or (iii)} | Payments made by a superannuation fund Payment of retirement benefits previously disclosed when accrued |
| Shares, units, options and rights in respect of remuneration<br>{equity compensation – 5.2(c)(i) or (ii)} | Dividends received on shares provided under an employee ownership scheme |
| Discounts on shares provided under an employee share ownership scheme that form part of the individual’s remuneration package<br>{equity compensation – 5.2(c)(i)} | Discounts on shares provided under an employee share ownership scheme that does not provide compensation<br> |
| Travel expenses for spouse or other family of director or executive and associated costs not incurred in the course of employment<br>{primary – non-monetary 5.2(a)(iii)} | Travel expenses for spouse or other family of director or executive and associated costs that are incurred in the course of employment |
| Other benefits including “golden handshakes” in connection with restrictive covenants<br>{post-employment – 5.2(b)(ii) or (iii) or termination – 5.2(d)(i) or (ii)}<br>or “sign-on” lump sums<br>{other benefits – 5.2(d)(iii)} | |
APPENDIX 2
EQUITY COMPENSATION FOR INDIVIDUAL REMUNERATION
This Appendix forms an integral part of the Standard
This Appendix provides directions on how the principles in Appendix 6 are applied in the context of this Standard to estimate remuneration to be disclosed for individuals.
Areas addressed are:
determination and allocation of value of equity compensation; and
alteration of the terms of remuneration options
References to options in this Appendix shall be read as including other equity instruments with equivalent functionality, such as rights and performance rights.
Determination and Allocation of Value of Equity Compensation
In applying the principles outlined in Appendix 6, the assumptions needed to arrive at the fair value of equity instruments must reflect the realities specific to the grant to a specified director or specified executive at grant date. When a grant vests immediately, the fair value is treated as remuneration of the individual in that reporting period. In situations where several executives are offered share-based payment compensation and each accepts on a different day, technically, the equity compensation for each individual would need to be treated as a separate grant, with a different grant date. When such multiple grants vest immediately, the time difference between grant dates is likely to be small and insufficient to warrant separate estimation of the value of each executive’s grant.
When a grant of equity compensation to an individual will vest over several reporting periods, the process of allocating the value of the grant to each reporting period as remuneration is likely to differ from the process appropriate to a grant for hundreds of employees. In cases of multi-employee grants of options subject only to service conditions, the value allocated in the first period is estimated as
the fair value of the option at grant date
x the total number of options per employee
x the percentage of the vesting period elapsed to date
x the number of employees expected to be employed at vesting date and satisfying the vesting conditions.
In subsequent periods prior to vesting date, the entity is required to reestimate the number of employees likely to be employed at vesting date, recalculate the value as described above and subtract the amount disclosed as remuneration in prior periods. In the final period in which vesting occurs, the total value of the grant is calculated based on the total number of vested options, being:
the fair value of the option at grant date
x the total number of options per employee
x the number of employees employed at vesting date (thus satisfying the vesting conditions).
In cases of grants of options to a specified person, the number of employees, being only one, will not change during the vesting period. It is assumed that grants of options with vesting conditions will only be made to directors or executives who are expected to remain until the end of the vesting period. If a director or executive leaves prior to vesting date and it is decided that outstanding grants will vest (and not be forfeited), the balance of the value remaining to be allocated will be disclosed as remuneration of that specified person in the reporting period in which they cease employment.
In cases of a grant of options where vesting date is reached and the options do not vest (because the vesting conditions are failed), there will be no amount to include in respect of that grant in the remuneration disclosed for that individual for the reporting period.
Alteration of Terms of Remuneration Options
If there is a change in the exercise price or number of equity instruments to be issued on exercise of an option as a consequence of the reorganisation of the equity structure of an entity, such a change is not classified as alteration of the terms of remuneration options and does not lead to inclusion of any amount as remuneration. Other changes initiated by the entity that are designed to increase the value of options granted as remuneration to specified persons are treated separately, depending on whether the options have vested.
Vested options
When the exercise price or other terms of vested options have been amended during the reporting period, the value of the options affected by the alteration and the value subsequent to alteration of the terms are measured to arrive at the difference required to be disclosed by paragraph 7.6(e). The date of measuring the second value is the date of the alteration of the terms, not the last day of the reporting period in which the alteration occurs.
When measuring the value of the options at the date of alteration of the terms, the same option-pricing model that was applied to measure the amount at grant date is applied, assuming the same option-pricing model remains valid, using the values of the variables at the date of alteration. The valuation process is repeated replacing where required the values for exercise price, expected life and risk-free rate with those representing the new terms. The difference disclosed is the total amount for the parcel of options affected, not the difference per option.
If the alteration of the terms affects several parcels of options held by a specified person, for example, extending by five years the life of all vested options currently held by that individual, then separate calculations will be needed for each parcel of options. Separate disclosure by parcel is necessary for the details required by paragraphs 7.6(c) and 7.6(d), but it would be acceptable to add together the differences for each parcel to provide the disclosure required by paragraph 7.6(e), to indicate the total gain to the specified person in the reporting period from alteration of the terms.
Unvested options
When the exercise price or other terms of options have been amended during the reporting period and before vesting date, the value of the options affected by the alteration and the value subsequent to alteration of the terms are measured to arrive at the difference required to be disclosed by paragraph 7.6(e).
Unlike vested options, the total value of the benefit in this instance is not included in remuneration for the reporting period in which the change occurs. The value is added to the originally-estimated value of the options that is being allocated as remuneration of a specified person over reporting periods from grant date to vesting date. Since the allocation to each period is based on the pro rata number of options relevant to each period, remuneration in the reporting period in which the change is made includes an amount representing an increase in the value of the number of equity instruments used to derive remuneration disclosed in prior reporting periods.
APPENDIX 3
REMUNERATION: DISCLOSURES ILLUSTRATED
This Appendix forms part of the commentary and is provided for illustrative purposes only. Table 3 illustrates how a disclosing entity might comply with requirements contained in paragraphs 7.1 and 7.2 of this Standard.
This Appendix forms part of the commentary and is provided for illustrative purposes only. Tables 4A to 4D illustrate how a disclosing entity might comply with requirements contained in Section 8 of this Standard. To assist in identifying the relevant paragraphs in the Standard, the paragraph numbers are indicated above the column headings.
This Appendix forms part of the commentary and is provided for illustrative purposes only. Table 5 illustrates how a disclosing entity might comply with requirements contained in Section 9 of this Standard. To assist in identifying the relevant paragraphs in the Standard, the paragraph numbers are indicated above the column headings.
Disclosure on an individual basis is required only when the aggregate loan of a specified director or specified executive exceeded $100,000 during the reporting period and comparative amounts are not required even if that individual was specified in the preceding reporting period. For group aggregates, disclosure of comparative amounts is required but not the highest amount outstanding during the reporting period.
A transaction with an employee in his/her capacity as a holder of equity instruments of the entity is not a share-based payment transaction. For example, if an entity grants all holders of a particular class of its equity instruments the right to acquire additional equity instruments of the entity at a price that is less than the fair value of those equity instruments, and an employee receives such a right because he/she is a holder of that particular class of equity instruments, the granting or exercise of that right is not classified as remuneration.
The entity shall measure the fair value of the employee services received by reference to the fair value of the equity instruments granted, because typically it is not possible to estimate reliably the fair value of the services received.
If the equity instruments granted vest immediately (i. e. the employee is not required to complete a specified period of service before becoming unconditionally entitled to those equity instruments), the entity shall presume that services rendered by the employee as consideration for the equity instruments have been received. In this case, on grant date the entity shall treat the full value of the grant of equity instruments as remuneration and include it in disclosures for that reporting period.
If the equity instruments granted do not vest until the employee completes a specified period of service, the entity shall presume that the services to be rendered by the employee as consideration for those equity instruments will be received in the future, during the vesting period. The entity shall treat the grant as remuneration for those services as they are rendered by the employee during the vesting period. The value of the grant is allocated proportionately to reporting periods between grant date and vesting date. For example:
(i) if an employee is granted share options conditional upon completing three years’ service, then the entity shall presume that the employee services will be received over that three-year vesting period and allocate one-third of the value of the grant to each year; or
(ii) if an employee is granted share options conditional upon the achievement of a performance condition and remaining in service until that performance condition is satisfied, and the length of the vesting period varies depending on when that performance condition is satisfied, the entity shall presume that the services will be received over the expected vesting period. The entity shall estimate the length of the expected vesting period at grant date, based on the most likely outcome of the performance condition. The entity shall revise its estimate of the length of the vesting period if subsequent information indicates that the length of the vesting period differs from previous estimates.
An entity shall measure the fair value at grant date of equity instruments granted, based on market prices if available, taking into account the terms and conditions upon which those equity instruments were granted, except for vesting conditions and reload features that are excluded from the measurement of fair value.
If market prices are not available, the entity shall estimate the fair value at grant date of the equity instruments granted using a valuation technique to estimate what the price of those equity instruments would have been on grant date in an arm’s length transaction between knowledgeable, willing parties. The valuation technique shall be consistent with generally accepted valuation methodologies for pricing financial instruments and shall incorporate all factors and assumptions that knowledgeable, willing market participants would consider in setting the price (except for vesting conditions and reload features that are excluded from the measurement of fair value).
Treatment of vesting conditions
A grant of equity instruments might be conditional upon satisfying specified vesting conditions. For example, a grant of shares or options to an employee is typically conditional on the employee remaining in the entity’s employ for a specified period of time. There might also be performance conditions that must be satisfied, such as the entity’s achieving a specified growth in profit or a specified increase in the entity’s share price. Vesting conditions shall not be taken into account when estimating the fair value of the shares or options at grant date. Instead, vesting conditions shall be taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount such that, ultimately, the amount treated as remuneration for services received as consideration for the equity instruments granted shall be based on the number of equity instruments that eventually vest. Ultimately, no amount is treated as remuneration for services received if the equity instruments granted do not vest because of failure to satisfy a vesting condition. For example, the employee fails to complete a specified service period or a performance condition is not satisfied.
The entity shall disclose as remuneration in each reporting period during the vesting period the pro rata amount based on the best available estimate of the number of equity instruments expected to vest. That estimate, if necessary, is revised when subsequent information indicates that the number of equity instruments expected to vest differs from initial estimates. On vesting date, the entity shall revise the estimate to equal the number of equity instruments that ultimately vested.
Treatment of a reload feature
For options with a reload feature, the reload feature shall not be taken into account when estimating the fair value of options at grant date. Instead, if and when a reload option is granted, the reload option shall be accounted for as a new option grant.
After vesting date
In reporting periods subsequent to that in which vesting occurs, the entity shall make no subsequent adjustment to remuneration disclosed in prior periods. For example, the entity shall not subsequently reverse an amount previously disclosed as remuneration for an employee if vested options are not exercised.
Modifications to the terms and conditions on which equity instruments were granted, including cancellations and settlements
An entity might modify the terms and conditions on which the equity instruments were granted. For example, it might reduce the exercise price of options granted to employees (i. e. reprice the options), which increases the fair value of those options.
The entity should treat the effects of modifications that are beneficial to the employee as follows.
When the modification occurs during the vesting period, the incremental fair value granted is included in the measurement of the amount allocated to remuneration for services received over the remainder of the vesting period, in addition to the amount based on the grant date fair value of the original equity instruments.
When the modification occurs on or after vesting date, the incremental fair value granted is treated as remuneration in that reporting period.
The incremental fair value granted is the difference between the fair value of the modified (or replacement) equity instruments and the net fair value of the original equity instruments at the date the modification (or replacement) occurs.
If the entity modifies before vesting date the terms or conditions of the equity instruments granted in a manner that is not beneficial to the employee, the entity shall nevertheless continue to disclose remuneration for the services received as consideration for the equity instruments granted as if that modification had not occurred (other than a cancellation of some or all the equity instruments granted, which shall be treated as described below).
When the entity cancels or settles a grant of equity instruments prior to vesting date (excluding forfeiture when the vesting conditions are not satisfied), the following principles apply.
The entity shall treat the cancellation or settlement as an acceleration of vesting, and shall therefore disclose immediately as remuneration the amount that would have otherwise been disclosed over the remainder of the vesting period.
Any payment made to the employee on the cancellation of the grant or as settlement (in lieu of any potential for rights to equity) shall be treated as the repurchase of an equity interest. To the extent that the payment exceeds the fair value of the shares or options granted, measured at the repurchase date, any such excess shall be disclosed as remuneration.
If new equity instruments are granted to the employee and, on the date when those new equity instruments are granted:
(a) the entity identifies the new equity instruments granted as replacement equity instruments for the cancelled equity instruments, the entity shall treat the granting of replacement equity instruments in the same way as a modification of the original grant of equity instruments; or
(b) if the entity does not identify new equity instruments granted as replacement equity instruments for the cancelled equity instruments, the entity shall treat those new equity instruments as a new grant of equity instruments.
When an entity repurchases vested equity instruments, on or after vesting date, and the payment exceeds the fair value of the equity instruments repurchased, measured at the repurchase date, any such excess shall be disclosed as remuneration in that reporting period.
An entity might grant share appreciation rights (SARs) to employees as part of their remuneration package, whereby the employees will become entitled to a future cash payment (rather than an equity instrument) based on the increase in the entity’s share price from a specified level over a specified period of time.
The entity shall treat such grants as remuneration as the employees render service. For example, some SARs vest immediately and the employees are not required to complete a specified period of service to become entitled to the cash payment. In the absence of evidence to the contrary, the entity shall presume that the services rendered by the employees in exchange for the SARs have been received. Thus, the entity shall disclose the value of the grant immediately as remuneration. If the SARs do not vest until the employees have completed a specified period of service, the entity shall allocate the number of rights proportionately to remuneration in the reporting periods, as the employees render service from grant date to vesting date.
When the SARs do not vest immediately, the remuneration disclosed is the difference in the estimated liability arising in the reporting period. The liability shall be estimated, initially and at each reporting date until settled, at the fair value of the SARs, by applying an option-pricing model, taking into account the terms and conditions on which the SARs were granted, and the extent to which the employees have rendered service to date.
Inputs to Option-Pricing Models
In estimating the expected volatility of and dividends on the underlying shares, the objective is to approximate the expectations that would be reflected in a current market or negotiated exchange price for the option. Similarly, when estimating the effects of early exercise of employee share options, the objective is to approximate the expectations that an outside party with access to detailed information about employees’ exercise behaviour would develop based on information available at the grant date.
Often, there is likely to be a range of reasonable expectations about future volatility, dividends and option life. If so, an expected value should be calculated, by weighting each amount within the range by its associated probability of occurrence.
Expectations about the future are generally based on past experience, modified if the future is reasonably expected to differ from the past. In some circumstances, identifiable factors may indicate that unadjusted historical experience is a relatively poor predictor of future experience. For example, if an entity with two distinctly different lines of business disposes of the one that was significantly less risky than the other, historical volatility may not be the best information on which to base reasonable expectations for the future.
In other circumstances, historical information may not be available. For example, a newly listed entity will have little, if any, historical data on the volatility of its share price. Newly listed entities are discussed further below.
In summary, an entity should not simply base estimates of volatility, expected life of option and dividends on historical information without considering the extent to which the past experience is expected to be reasonably predictive of future experience.
Expected early exercise
The expected life of an option is frequently shorter than its contractual life because employees often exercise share options early, for a variety of reasons. For example, employee share options are typically non-transferable. This often causes employees to exercise their share options early, because that is the only way for the employees to liquidate their position. Also, employees who cease employment may be required to exercise any vested options held within a short period of time, precipitating the early exercise of employee share options. Other factors causing early exercise are risk aversion and lack of wealth diversification.
The means by which the effects of expected early exercise are taken into account depend upon the type of option-pricing model applied. For example, expected early exercise behaviours could be taken into account by using an estimate of the option’s expected life (which, for an employee share option, is the period of time from grant date to the date on which the option is expected to be exercised) as an input into an option-pricing model. Alternatively, expected early exercise parameters could be modelled in a binomial or similar option-pricing model that uses contractual life as an input.
Factors to consider in estimating the effect of early exercise on the life of an option include:
(i) the length of the vesting period, because the share option typically cannot be exercised until the end of the vesting period. Hence, determining the valuation implications of expected early exercise is based on the assumption that the options will vest, and expected life cannot be less than the vesting period;
(ii) the average length of time similar options have remained outstanding in the past;
(iii) the price of the underlying shares. Past experience may indicate that the employees tend to exercise options when the share price reaches a specified level above the exercise price;
(iv) the employee’s level within the organisation. For example, past experience might indicate that higher-level employees tend to exercise options later than lower-level employees (discussed further below); and
(v) expected volatility of the underlying shares. On average, employees might tend to exercise options on highly volatile shares earlier than on shares with low volatility.
If the entity applies the Black-Scholes-Merton formula to value the share options, the effects of early exercise are taken into account by using the option’s expected life as an input into the formula. When estimating the expected life of share options granted to a group of employees, the entity could base that estimate on an appropriately weighted average expected life for the entire employee group or on appropriately weighted average lives for subgroups of employees within the group, based on more detailed data about employees’ exercise behaviour.
Separating an option grant into groups for employees with relatively homogeneous exercise behaviour is likely to be important. Option value is not a linear function of option term; value increases at a decreasing rate as the term lengthens. For example, if all other assumptions are equal, although a two-year option is worth more than a one-year option, it is not worth twice as much. That means that calculating estimated option value on the basis of a single weighted average life that includes widely-differing individual lives would overstate the total fair value of the share options granted. Separating options granted into several groups, each of which has a relatively narrow range of lives included in its weighted average life, reduces that overstatement.
Similar considerations apply when using a binomial or similar model. For example, the experience of an entity that grants options broadly to all levels of employees might indicate that top-level executives tend to hold their options longer than middle-management employees hold theirs and that lower-level employees tend to exercise their options earlier than any other group. In addition, employees who are encouraged or required to hold a minimum amount of their employer’s equity instruments, including options, might on average exercise options later than employees not subject to that provision. In those situations, separating options by groups of recipients with relatively homogeneous exercise behaviour will result in a more accurate estimate of the total fair value of the share options granted.
Expected volatility
Expected volatility is a measure of the amount by which a price is expected to fluctuate during a period. The measure of volatility used in option-pricing models is the annualised standard deviation of the continuously compounded rates of return on the share over a period of time. Volatility is typically expressed in annualised terms that are comparable regardless of the time period used in the calculation, for example, daily, weekly or monthly price observations.
The rate of return (which may be positive or negative) on a share for a period measures how much a shareholder has benefited from dividends and appreciation (or depreciation) of the share price.
The expected annualised volatility of a share is the range within which the continuously compounded annual rate of return is expected to fall approximately two-thirds of the time. For example, to say that a share with an expected continuously compounded rate of return of 12 per cent has a volatility of 30 per cent means that the probability that the rate of return on the share for one year will be between –18% (12% – 30%) and +42% (12% + 30%) is approximately two-thirds. If the share price is $100 at the beginning of the year and no dividends are paid, the year-end share price would be expected to be between $83.53 ($100×e–0.18) and $152.20 ($100×e0.42) approximately two-thirds of the time.
The following factors should be considered in estimating expected volatility.
Implied volatility from traded share options over the entity’s shares, or other traded instruments of the entity that include options features (such as convertible debt), if any.
The historical volatility of the share price over the most recent period that is generally commensurate with the expected term of the option (taking into account the remaining contractual life of the option and the effects of expected early exercise).
The length of time an entity’s shares have been publicly traded. A newly listed entity might have a high historical volatility, compared with similar entities that have been listed longer. Further guidance for newly listed entities is given below.
The tendency of volatility to revert to its mean (being its long-term average level) as well as other factors indicating that expected future volatility might differ from past volatility. For example, if an entity’s share price was extraordinarily volatile for some identifiable period of time because of a failed takeover bid or a major restructuring, that period could be disregarded in computing historical average annual volatility.
Appropriate and regular intervals for price observations. The price observations should be consistent from period to period. For example, an entity might use the closing price for each week or the highest price for the week, but it should not use the closing price for some weeks and the highest price for other weeks. Also, the price observations should be expressed in the same currency as the exercise price.
Newly listed entities
As noted above, an entity should consider historical volatility of the share price over the most recent period that is generally commensurate with the expected option term. If a newly listed entity does not have sufficient information on historical volatility, it should nevertheless compute historical volatility for the longest period for which trading activity is available. It could also consider the historical volatility of similar entities following a comparable period in their lives. For example, an entity that has been listed for only one year and grants options with an average expected life of five years might consider the pattern and level of historical volatility of entities in the same industry that have been listed longer for the first six years in which the shares of those entities were publicly traded.
Expected dividends
Whether expected dividends should be taken into account when measuring the fair value of shares or options granted depends on whether the counterparty is entitled to dividends or dividend equivalents.
For example, if employees were granted options and are entitled to dividends on the underlying shares or dividend equivalents (which might be paid in cash or applied to reduce the exercise price) between grant date and exercise date, the options granted should be valued as if no dividends will be paid on the underlying shares, that is, the input for expected dividends should be zero.
Similarly, in estimating the grant date valuation of shares granted to employees, no adjustment is required for expected dividends if the employee is entitled to receive dividends paid during the vesting period.
Conversely, if the employees are not entitled to dividends or dividend equivalents during the vesting period (or before exercise, in the case of an option), the grant date valuation of the rights to shares or options should take expected dividends into account. That is to say, in estimating the fair value of an option grant, expected dividends should be included in the application of an option-pricing model. In estimating the fair value of a share grant, that valuation should be reduced by the present value of dividends expected to be paid during the vesting period.
Option-pricing models generally call for expected dividend yield. However, the models may be modified to use an expected dividend amount rather than a yield. An entity may use either its expected yield or its expected payments. If the entity uses the latter, it should consider its historical pattern of increases in dividends. For example, if an entity’s policy has generally been to increase dividends by approximately 3 per cent per year, its estimated option value should not assume a fixed dividend amount throughout the expected life unless there is evidence that supports that assumption.
Generally, the assumption about expected dividends should be based on publicly available information. An entity that does not pay dividends and has no plans to do so should assume an expected dividend yield of zero. However, an emerging entity with no history of paying dividends might expect to begin paying dividends during the expected lives of its employee stock options. Those entities could use an average of their past dividend yield (zero) and the mean dividend yield of an appropriately comparable peer group.
Risk-free interest rate
The risk-free interest rate is the implied yield currently available on zero-coupon government issues with a remaining term equal to the expected term of the option being valued (based on the option’s remaining contractual life and taking into account the effects of expected early exercise behaviours). It may be necessary to use an appropriate substitute, if no such government issues exist with a life equal to the expected term of the option being valued.
Capital structure effects
Typically, third parties, not the entity, write traded share options. When these share options are exercised, the writer delivers shares to the option holder. Those shares are acquired from existing shareholders. Hence the exercise of traded share options has no dilutive effect.
In contrast, if share options are written by the entity, new shares are issued when those share options are exercised (either actually issued or issued in substance, if shares previously repurchased and held in treasury are used). Given that the shares will be issued at the exercise price rather than the current market price at the date of exercise, this actual or potential dilution might reduce the share price, so that the option holder does not make as large a gain on exercise as on exercising an otherwise similar traded option that does not dilute the share price.
Whether this has a significant effect on the value of the share options granted depends on various factors, such as the number of new shares that will be issued on exercise of the options compared with the number of shares already on issue. Also, if the market already expects that the option grant will take place, the market may have already factored the potential dilution into the share price at the date of grant.
However, the entity should consider whether the possible dilutive effect of the future exercise of the share options granted might have an impact on their estimated fair value at grant date. Option-pricing models can be adapted to take into account this potential dilutive effect.