Date: December 31, 1996 Source: State of California Secretary of State (AB 3194) Headline: California Qualified Stock Options (CQSOs) Summary A little-noticed piece of legislation will become effective January 1, 1997 creating the California Qualified Stock Option (CQSO). CQSOs are intended as a hybrid of Incentive Stock Options (ISOs) and Employee Stock Purchase Plans (ESPPs or Section 423 Plans) under federal tax law. The bill received unanimous approval by both the Senate and Assembly and was approved by Governor Wilson on September 26. CQSO requirements will be similar to ISOs with 2 important distinctions: they will allow a discount from fair market value at the date of grant -- like a nonqualified stock option or employee stock purchase plan -- and will not require the ISO holding periods (two years from date of grant, one year from date of exercise. CQSOs will be limited to employees with less than $40,000 earned income. CQSOs may be granted beginning January 1, 1997 and exercised prior to January 1, 2002. The supporters of the bill state that CQSOs are "intended to provide employers an opportunity to attract good employees and reward their performance with a new form of stock options (sic) that combines (sic) the best features of existing stock purchase plans." CPM Observations Like ISOs, CQSOs will be quite expensive for employers who will lose the corporate tax deduction in return for the deferral and capital gains treatment of employee option gains. The relative costs will be more pronounced given the lower-income focus of CQSOs. Conversely, growth companies who have yet to reach profitability -- in industries such as biotechnology -- may find that CQSOs provide greater benefits to employees with fewer restrictions at no incremental cost to the company. Employers must analyze the aftertax cost of CQSOs considering marginal tax rates for the employer and the employee; there continue to be few situations where ISOs optimize employer and employee after tax gains. In addition to tax considerations, employers must be aware of accounting costs of discounted options; potential investor reactions to discounted options; the increased benefits to the employee of CQSOs over ISOs, NQSOs, and ESPPs; the total compensation impact of issuing options to previously noneligible employees; and the need for thorough communications when extending new equity-based forms of compensation to an employee group. Index: alleeso.002 Recently in "Performance Bytes"... August 22, 1997 "Management Pay -- Unintended Consequences" The Economist, August 22, 1997 [strategy.002] March 7, 1997 "Performance Stock Options" Congressional Record, January 21, 1997 [alleeso.004] February 24, 1997 "Most EDS Employees To Get Stock Options..." Wall Street Journal, February 24, 1997 [alleeso.003] January 29, 1997 "American Air Pilots Asked to Agree to Arbitration" Wall Street Journal, January 29, 1997 [union.001] January 24, 1997 "A Tale of Two Compensation Strategies: (Eastman Kodak & AlliedSignal)" Fortune, January 13, 1997 [strategy.001] January 8, 1997 "Small Concerns Are More Likely to Pay Directors in Stock Than Large Firms" Wall Street Journal, January 8, 1997 [bdcomp.001] December 31, 1996 California Qualified Stock Options (CQSOs) State of California, Secretary of State (AB 3194) [alleeso.002] December 27, 1996 "All about EVA" CFO Magazine, November, 1996 [perfmeas.001] December 18, 1996 "Stock Options to Be Given to 69,000 Staff Members" (Chase Manhattan Corp.) Wall Street Journal, December 18, 1996 [alleeso.001]