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How to Account for Spring Loaded Options [Video]

How to Account for Spring Loaded Options

Spring-loaded options are stock-based compensation granted to executives right before a company announces good news.

People have criticized companies for giving spring-loaded options, and here’s why: When a company issues stock options to its executives, the company has to record compensation expense for the fair value of the stock options on the grant date (ASC 718).

Thus, if a company grants stock options to its CEO on January 20, and the fair value of those options on January 20 is $10 million, the company would record $10 million of compensation expense.

But what if the company knew it was going to report better-than-expected earnings the next day on January 21? Or what if the company knew it was going to announce that it landed a new contract with a large customer? This would be good news, so the stock price is likely to go up. If it does, the value of the options will also go up.

On November 29, 2021 the SEC issued Staff Accounting Bulletin 120. This says that companies granting options before announcing material nonpublic information must consider whether the stock price on the grant date needs to be adjusted when valuing the options.

Now, to be fair, companies frequently possess material nonpublic information. Thus, SAB 120 focuses on non-routine awards that are intentionally granted prior to announcing good news with the expectation that the stock price will go up. An example of non-routine would be if the company normally awards stock-based compensation every year on January 31 but suddenly awards the options on January 17 right before a press release announcing better-than-expected earnings.

Also, if a company does grant spring-loaded options, it not only needs to consider adjusting the fair value of the options on the grant date but should also disclose the characteristics of those spring-loaded options if the characteristics differ from its other stock-based compensation.

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