Recommendations on Long-Term Incentive Stock Compensation

Blog
February 2, 2022
Long-Term Incentive Plan

Characteristics

  • Participants: Generally, all eligible employees (e.g., excludes interns, etc.)
  • Awards: Granted based on tiering of employee’s base compensation. For example, employees making 0-$50k get X% in RSUs, >$50k – $100k get Y% etc.
  • Vesting: Generally Four-year graded vesting (25% per year)
  • Valuation: Based on publicly quoted market price on date of grant.
  • A formal Agreement exists

Assessment 

  • Long term incentive amounts which vest in the accounting year are allowable if:
    • Written Long-Term Incentive Plan agreements are in place,
    • Each recipient has received written communication of their reward
    • The company can demonstrate how the employee awards were calculated
  • LTI is included in the Total Compensation (Base Salary, Bonus/Incentive, Health/Life/Insurance and other compensation) shall be below the regulatory threshold (see the Compensation Cap section below).
  • LTI should pass the “reasonableness” test (see the Reasonableness section below).
  • If both are true a company can claim 100% of the employee’s compensation in its Incurred Cost claim to the government.

FAR 31.205-6(f)(1) Bonuses and Incentive Compensation

Bonuses and Incentive compensation are allowable provided the:

  • Awards are paid or accrued under an agreement entered into in good faith between the contractor and the employees before the services are rendered, or pursuant to an established plan or policy followed by the contractor so consistently as to imply, in effect, an agreement to make such a payment; and
  • Basis for the award is supported

Compensation Cap 

  • The Executive Compensation limit for government contractors, as established by Section 702 of the Bipartisan Budget Act of 2013 (BBA; Pub. L. 113-67, December 26, 2013), for the year ending December 31, 2021, is $589,000.

Reasonableness

  • The allowable bonuses and incentive costs should be included with the allowable portion of the other components of the contractor’s compensation when determining whether the total allowable compensation costs for high risk employees are reasonable in accordance with FAR 31.205-6(b).
  • The employees’ total compensation should be compared to official market surveys, showing that compensation for a particular position is within the 50th  If not, the company should document why this position’s compensation is higher than the 50th percentile.  For example, the position is very specialized and only a few people are qualified to perform the responsibilities of the position.
Employee Stock Purchase Plan
  • Participants: Generally all eligible employees (e.g., excludes interns, etc.). Participation is voluntary.
  • Awards: Employees who choose to participate have payroll withholdings. The company will accumulate these payroll withholdings and then purchase shares on the market at pre-defined dates (likely semi-annually). Participants will receive a 15% discount based on the lower of the market price as of the beginning of the offering period vs. the end of the offering period.
  • Vesting: N/A – participants are fully-vested in the shares that they purchase through the plan.
  • Valuation: Based on publicly quoted market price; 15% discount depending on lower of stock price at the beginning vs. end of the offering period.

Assessment

  • Employee Stock Purchase Plans (ESPP) have little or no out-of-pocket cost to the company and have no unallowability implications to contract billings
  • The ESPP is voluntary.
  • A written agreement exists which has been distributed to its employees.
Stock Options
  • Participants: Certain key executives.
  • Awards: Subject to management discretion.
  • Vesting: Four-year graded vesting (25% per year)
  • Valuation: Typically they are valued using the Black-Sholes model. Exercise price is based on publicly quoted market price on date of grant.
  • An agreement is in place between employee and company

Assessment

  • Stock Options as compensation to employees are unallowable under the FAR:
  • GAAP requires a company to expense some amount of the stock option today, as an estimate of what it expects to pay later.
  • The most common method of stock option valuation for GAAP purposes is the Black-Sholes model. However, the FAR does not permit government contractors to comply with GAAP requirements.
  • Compensation based on changes in the prices of corporate securities is unallowable.
  • This was confirmed in an ASBCA case from 2007 (ASBCA No. 60086) where the Board agreed with DCAA that compensation expense recognized using the Black-Scholes approach is unallowable.

Recommendations

  • Review open years’ submissions to ensure costs are unallowable
  • If costs were included in rates and are unreasonable, recalculate and resubmit open years
  • The following FAR Clause applies:
    • FAR 31.205-6(i) Compensation for Personal Services- Compensation based on changes in the prices of corporate securities or corporate security ownership, such as stock options, stock appreciation rights, phantom stock plans, and junior stock conversions.
      • Any compensation which is calculated, or valued, based on changes in the price of corporate securities is unallowable
      • Any compensation represented by dividend payments or which is calculated based on dividend payments is unallowable
      • If a contractor pays an employee in lieu of the employee receiving or exercising a right, option, or benefit which would have been unallowable under this paragraph (i), such payments are also unallowable
Performance Stock Units (PSU)
  • Participants: selected key employees or leadership
  • Awards: Subject to management discretion.
  • Vesting: Based on certain performance metrics (e.g., commercial revenue target in a fiscal year)
  • Valuation: per share price at time of notification
  • Agreement is established with employee and company

Assessment

  • The same rules and regulations apply as in item #1 for allowability and reasonableness of the Employee’s total compensation.

Recommendations

  • The value of the PSUs should be calculated at the end of each vesting period
  • The target PSUs are then valued with the current market value of company share price.
  • The calculated value of the PSU is considered part of the employee’s compensation.
Aronson’s Overall Recommendations
  • Budget these allowable incentives at the beginning of the accounting year and accrue monthly.
  • Revisit the calculations mid year, and if needed update accruals in the accounting system.
  • End of Year – calculate the value of the incentives based on actual results and true-up the incentive accruals.
  • Budget incentives in the Pool cost for the provisional billing rates
  • Disclosure Statement, include the types of incentives in the Pool Cost description of the applicable Rate Pools
  • DCAA likes to audit incentives. It is important to have support for calculations, and approvals.