Employee Stock Options: Definitions and Key Concepts.
Before delving into the finer details of Employee Stock Options (ESOs), it is crucial to have an understanding of basic option terms. Here’s a brief description of 10 key option terms you should know.
Call Option : Also known simply as a “Call,” a call option gives the buyer the right but not the obligation to buy the underlying security or asset at a certain price within a defined period of time. The call buyer thus benefits when the underlying security or asset increases in price.
(Option) Exercise : For a call buyer, option exercise means executing the right to buy the underlying security at the exercise price or strike price. For a put buyer, option exercise means executing the right to sell the underlying security at the exercise price or strike price.
Exercise Price or Strike Price : The price at which the underlying asset can be purchased (for a call option) or sold (for a put option); the exercise price or strike price is determined at the time of formation of the option contract.
Expiration Date : The last day of validity for an options contract, after which it expires worthless. The time left to expiration is a key determinant of the price of an option; in general terms, the longer the time to expiration, the higher the option price.
In the money (ITM) : A term that indicates the option has intrinsic value, i. e. for a call option, the market price of the underlying security is higher than the exercise price, and for a put option, the market price is lower than a put option. Conversely, an option is said to be “ out of the money ” (OTM) if the market price of the underlying is lower than the exercise price for a call option, or the market price is higher than the exercise price for a put option. An option is said to be “ at the money ” (ATM) if the market price of the underlying is equal to the exercise price for a call option, as well as for a put option.
Intrinsic Value : A call has intrinsic value if the market price of the underlying asset is higher than the exercise price. A put has intrinsic value if the market price of the underlying asset is lower than the exercise price.
Option Premium : The price paid by an option buyer to the option seller or “writer,” generally quoted on a per-share basis. The premium is paid up front by the buyer at the time of option purchase and is not refundable.
Spread : The difference between the market price of the underlying security and the exercise price of the option, at the time of exercise.
Time Value : One of the two components – along with intrinsic value – of an option’s price or premium, time value is any premium in excess of an option’s intrinsic value. For an option with zero intrinsic value, the full premium is attributable to time value.
Underlying (Asset) : The financial asset or security on which an option’s price is based, and which must be delivered to the option buyer upon exercise.
Now let’s look specifically at ESOs, and begin with the participants – the grantee (employee) and grantor (employer). The grantee – also known as the optionee – can be an executive or an employee, while the grantor is the company that employs the grantee. The grantee is given equity compensation in the form of ESOs, usually with certain restrictions, one of the most important of which is the vesting period .
The vesting period is the length of time that an employee must wait in order to be able to exercise his or her ESOs. Why does the employee need to wait? Because it gives the employee an incentive to perform well and stay with the company. Vesting follows a pre-determined schedule that is set up by the company at the time of the option grant.
ESOs are considered vested when the employee is allowed to exercise the options and purchase the company’s stock. Note that the stock may not be fully vested in certain cases, despite exercise of the stock options, as the company may not want to run the risk of employees making a quick gain (by exercising their options and immediately selling their shares) and subsequently leaving the company.
If you are in line for an options grant, you must carefully go through your company’s stock options plan, as well as the options agreement, to determine the rights available and restrictions applied to employees. The stock options plan is drafted by the company’s Board of Directors and contains details of the grantee’s rights. The options agreement will provide the key details of your option grant such as the vesting schedule, how the ESOs will vest, shares represented by the grant, and the exercise or strike price. If you are a key employee or executive, it may be possible to negotiate certain aspects of the options agreement, such as a vesting schedule where the shares vest faster, or a lower exercise price. It may also be worthwhile to discuss the options agreement with your financial planner or wealth manager before you sign on the dotted line.
ESOs typically vest in chunks over time at pre-determined dates, as set out in the vesting schedule. For example, you may be granted the right to buy 1,000 shares, with the options vesting 25% per year over four years with a term of 10 years. So 25% of the ESOs, conferring the right to buy 250 shares would vest in one year from the option grant date, another 25% would vest two years from the grant date, and so on.
If you don’t exercise your 25% vested ESOs after year one, you would have a cumulative increase in exercisable options; thus after year two, you would now have 50% vested ESOs. If you do not exercise any of ESOs options in the first four years, you would have 100% of the ESOs vested after that period, which you can then exercise in full or in part. As mentioned earlier, we had assumed that the ESOs have a term of 10 years. This means that after 10 years, you would no longer have the right to buy shares; therefore, the ESOs must be exercised before the 10-year period (counting from the date of the option grant) is up.
Paying for the Stock.
Continuing with the above example, let’s say you exercise 25% of the ESOs when they vest after one year. This means you would get 250 shares of the company’s stock at the strike price.
It should be emphasized that the price you have to pay for the shares is the exercise price or strike price specified in the options agreement, regardless of the actual market price of the stock. Withholding tax and other related state and federal income taxes are deducted at this time by the employer, and the purchase price will typically include these taxes in the stock price purchase cost.
You would need to come up with the cash to pay for the stock. This is a nice problem to have, especially if the market price is significantly higher than the exercise price, but it does mean that you may have a cash-flow issue in the short term.
Cash exercise – wherein payment has to be made in cash for shares purchased by exercise of an ESO – is the only route for option exercise allowed by some employers. However, other employers now allow cashless exercise, which involves an arrangement made with a broker or other financial institution to finance the option exercise on a very short-term basis, and then have the loan paid off with the immediate sale of all or part of the acquired stock.
The ESO Spread and Taxation.
We now arrive at the ESO Spread. Since the acquired stock can be immediately sold in the market at the prevailing price, the higher the market price is from the exercise price, the larger the “spread” and hence the compensation (not the “gain”) earned by the employee. As will be seen later, this triggers a tax event whereby ordinary income tax is applied to the spread.
The following points need to be borne in mind with regard to ESO taxation (see Get The Most Out Of Employee Stock Options ):
The option grant itself is not a taxable event . The grantee or optionee is not faced with an immediate tax liability when the options are granted by the company. Note that usually (but not always), the exercise price of the ESOs is set at the market price of the company’s stock on the day of the option grant . Taxation begins at the time of exercise . The spread (between the exercise price and the market price) is also known as the bargain element in tax parlance, and is taxed at ordinary income tax rates because the IRS considers it as part of the employee’s compensation. The sale of the acquired stock triggers another taxable event . If the employee sells the acquired shares for less than or up to one year after exercise, the transaction would be treated as a short-term capital gain and would be taxed at ordinary income tax rates. If the acquired shares are sold more than one year after exercise, it would qualify for the lower capital gains tax rate.
Let’s demonstrate this with an example. Let’s say you have ESOs with an exercise price of $25, and with the market price of the stock at $55, wish to exercise 25% of the 1,000 shares granted to you as per your ESOs.
You would therefore need to pay $6,250 (ignoring taxes for the moment) for the shares ($25 x 250 shares). Since the market value of the shares is $13,750, if you promptly sell the acquired shares, you would net pre-tax earnings of $7,500. This spread is taxed as ordinary income in your hands in the year of exercise, even if you do not sell the shares . This aspect can give rise to the risk of a huge tax liability, if you continue to hold the stock and it plummets in value, as thousands of workers in the technology sector discovered in the aftermath of the 2000-02 “tech wreck” (see “Tech workers stock options turn into tax nightmares’’).
Let’s recap an important point – why are you taxed at the time of ESO exercise? The ability to buy shares at a significant discount to the current market price (a bargain price, in other words) is viewed by the IRS as part of the total compensation package provided to you by your employer, and is therefore taxed at your income tax rate. Thus, even if you do not sell the shares acquired pursuant to your ESP exercise, you trigger a tax liability at the time of exercise.
Table 1: Example of ESO Spread and Taxation.
Intrinsic Value vs. Time Value for ESOs.
The value of an option consists of intrinsic value and time value. Time value depends on the amount of time remaining until expiration (the date when the ESOs expire) and several other variables. Given that most ESOs have a stated expiration date of up to 10 years from the date of option grant, their time value can be quite significant. While time value can be easily calculated for exchange-traded options, it is more challenging to calculate time value for non-traded options like ESOs, since a market price is not available for them.
To calculate the time value for your ESOs, you would have to use a theoretical pricing model like the well-known Black-Scholes option pricing model (see ESOs: Using the Black-Scholes Model ) to compute the fair value of your ESOs. You will need to plug inputs such as the exercise price, time remaining, stock price, risk-free interest rate, and volatility into the Model in order to get an estimate of the fair value of the ESO. From there, it is a simple exercise to calculate time value, as can be seen in Table 2. Remember that intrinsic value – which can never be negative – is zero when an option is “at the money” (ATM) or “out of the money” (OTM); for these options, their entire value therefore consists only of time value.
The exercise of an ESO will capture intrinsic value but usually gives up time value (assuming there is any left), resulting in a potentially large hidden opportunity cost. Assume that the calculated fair value of your ESOs is $40, as shown in Table 2. Subtracting intrinsic value of $30 gives your ESOs a time value of $10. If you exercise your ESOs in this situation, you would be giving up time value of $10 per share, or a total of $2,500 based on 250 shares.
Table 2: Example of Intrinsic Value and Time Value (In the Money ESO)
The value of your ESOs is not static, but will fluctuate over time based on movements in key inputs such as the price of the underlying stock, time to expiration, and above all, volatility. Consider a situation where your ESOs are out of the money, i. e. the market price of the stock is now below the ESOs exercise price (Table 3).
Table 3: Example of Intrinsic Value and Time Value (Out of the Money ESO)
It would be illogical to exercise your ESOs in this scenario for two reasons. Firstly, it is cheaper to buy the stock in the open market at $20, compared with the exercise price of $25. Secondly, by exercising your ESOs, you would be relinquishing $15 of time value per share. If you think the stock has bottomed out and wish to acquire it, it would be much more preferable to simply buy it at $25 and retain your ESOs, giving you larger upside potential (with some additional risk, since you now own the shares as well).

Performance vested stock options

SunTrust Banks, Inc.
2009 Stock Plan.
PERFORMANCE-VESTED STOCK OPTION (PVO)
SunTrust Banks, Inc. (“SunTrust”), a Georgia corporation, pursuant to action of the Compensation Committee (“Committee”) of its Board of Directors and in accordance with the SunTrust Banks, Inc. 2009 Stock Plan (“Plan”), has granted a Performance-Vested Stock Option (“PVO”) to purchase shares of SunTrust Common Stock, $1.00 par value (“Stock”), upon the following terms as an incentive for Optionee to promote the interests of SunTrust and its Subsidiaries:
Fair Market Value Per Share.
On Grant Date and Option Price.
This Option Agreement (the “Option Agreement”) evidences this PVO grant, which has been made subject to all the terms and conditions set forth on the attached Terms and Conditions and in the Plan.
§ 1. GRANT DATE, EXERCISE PERIOD, EXPIRATION DATE. Subject to earlier termination or exercise as provided herein, this PVO granted on [Grant Date] (the “Grant Date”) shall expire at the end of the ten (10) year period (the “Exercise Period”) beginning on the Grant Date and ending at the end of the last day of the Exercise Period (the “Expiration Date”).
§ 2. PERFORMANCE-BASED VESTING. A percentage of this PVO, if it has not earlier vested or expired, shall vest and become exercisable on December 31, 2011 (the “Vesting Date”), based on SunTrust’s attainment of the Performance Level, set forth in the table below; provided, that the Optionee has remained in continuous employment with SunTrust or a Subsidiary from the Grant Date through the Vesting Date. A portion of this PVO may vest and become exercisable prior to the Vesting Date in accordance with the provisions of § 3. Once a portion of this PVO has vested, it may be exercised, in whole or in part, at any time and from time to time during the remainder of the Exercise Period unless the PVO expires before then pursuant to § 4.
SunTrust’s TSR Percentile on the.
Percentage of PVO That Vests.
The percentage of the PVO that vests if SunTrust’s TSR Percentile on the Vesting Date is between the “Threshold” and “Target; Maximum” Performance Levels shall be determined by linear interpolation. The Committee shall determine the portion of the PVO that shall vest and become exercisable by multiplying the “Percentage of PVO That Vests,” set forth above, by the number of shares subject to this Option Agreement.
§ 3. ACCELERATED VESTING; TERMINATION OF EMPLOYMENT. Some or all of this PVO may vest early and become exercisable as a result of the Optionee’s termination of employment with SunTrust and all its Subsidiaries prior to the Vesting Date, as described below in § 3(a), § 3(b), § 3(c) or § 3(d). If prior to the Vesting Date, the Optionee’s employment with SunTrust and its Subsidiaries terminates for any reason other than those described below, this PVO shall immediately and automatically without any action on the part of the Optionee or SunTrust terminate and be completely forfeited on the date of such termination of the Optionee’s employment.
(a) If the Optionee’s employment with SunTrust terminates prior to the Vesting Date and the date of a Change in Control, as a result of the Optionee’s (i) death, or (ii) Disability, a portion of the PVO shall vest and become exercisable on the date the Optionee’s employment terminates. The portion of the PVO, if any, that vests will be based on the portion of the PVO that would have vested if the Performance Period ended on such date (based on the actual Performance Level achieved (or the Target Performance Level, if such termination occurs less than one (1) year after the Grant Date)). Such vested portion of the PVO shall remain exercisable for the period described in § 4(b). In the event of such death of Disability, any portion of the PVO that does not vest pursuant to this § 3(a) shall terminate and be completely forfeited on such date.
(b) If the Optionee’s employment with SunTrust terminates prior to the Vesting Date and the date of a Change in Control, as a result of the Optionee’s Retirement, the PVO shall vest and become exercisable with respect to a pro-rata number of shares of Stock on the last day of the Performance Period, if any, based on the Optionee’s service completed from the Grant Date through the date of such Optionee’s actual retirement date. Such vested portion of the PVO shall remain exercisable for the period described in § 4(c).
(c) If the Optionee’s employment with SunTrust is involuntarily terminated prior to the Vesting Date and the date of a Change in Control, by reason of a reduction in force which results in the Optionee’s eligibility for payment of a severance benefit pursuant to the terms of the SunTrust Banks, Inc. Severance Pay Plan or any successor to such plan, the PVO shall vest and become exercisable with respect to a pro-rata number of shares of Stock at the end of the Performance Period, if any, based on the Optionee’s service completed from the Grant Date through the date of such termination. Such vested portion of the PVO shall remain exercisable for the three month (3) period following the Vesting Date.
(d) In the event a Change in Control occurs prior to the Vesting Date and on or prior to the Optionee’s termination of employment, upon the earlier of: (i) the Vesting Date, provided that the Optionee has remained in continuous employment with SunTrust or a Subsidiary from the Grant Date through the Vesting Date; or (ii) the date of the Optionee’s termination of employment with SunTrust and its Subsidiaries as a result of: (A) an involuntary termination by SunTrust that does not constitute a Termination for Cause; (B) the Optionee’s death or Disability; or (C) a voluntary termination by the Optionee as a result of Retirement or a Termination for Good Reason; the PVO shall vest and become exercisable with respect to the following number of shares of Stock: (1) the number of shares that would have vested (if any) if the Performance Period ended on the date of the Change in Control (based on the actual Performance Level achieved through the date of the Change in Control) multiplied by a fraction, the numerator of which shall be the number of days from the Grant Date through the date of such Change in Control, and the denominator of which shall be the total number of days in the original Performance Period; plus (2) the number of shares that would have vested assuming SunTrust’s achievement of the Target Performance Level multiplied by a fraction, the numerator of which shall be the number of days from the date of such Change in Control through the last day of the original Performance Period, and the denominator of which shall be the total number of days in the original Performance Period. Such vested portion of the PVO shall remain exercisable for the period described in § 4(d). In the event of such Change in Control, any portion of the PVO that does not vest pursuant to this § 3(d) shall terminate and be completely forfeited on the earlier of the Vesting Date or the date of termination of the Optionee’s employment.
Notwithstanding anything herein to the contrary, if the Optionee is subject to the terms of a Change in Control Agreement on the date of a Change in Control that provides for more generous vesting, such vesting provisions of the Change in Control Agreement shall govern.
(e) For purposes of § 3(b) and 3(c) above, the PVO shall vest with respect to the pro-rata number of shares of Stock equal to the product of: (i) the number of shares that would have vested based on the actual Performance Level achieved as of the Vesting Date; multiplied by (ii) a fraction, the numerator of which is equal to the number of days from the Grant Date through the date of such termination of employment, and the denominator of which is equal to the number of days in the Performance Period. Fractional shares shall be disregarded. In the event of such pro-rata vesting described above, any portion of the PVO that does not vest pursuant to this § 3(e) shall terminate and be completely forfeited on such date.
§ 4. EXPIRATION. To the extent not previously exercised, this PVO shall expire and cease to be exercisable on the Expiration Date or if earlier, on the first of the following events to occur:
(a) Except as otherwise described in this § 4 or § 3(c), if Optionee’s employment with SunTrust and all its Subsidiaries terminates for any reason, then Optionee may, within the three (3) month period following such termination, but in no event after the Expiration Date, exercise this PVO to the extent Optionee was entitled to exercise this PVO at the date of such termination of employment.
(b) In the event Optionee’s termination of employment with SunTrust and all Subsidiaries is due to death or Disability, any portion of the PVO that becomes vested and exercisable pursuant to § 2 or § 3(a), to the extent not previously exercised, shall remain exercisable through the end of the one (1) year period which begins on the date of Optionee’s death or Disability, but in no event after the Expiration Date.
(c) In the event Optionee terminates employment with SunTrust and all its Subsidiaries due to Retirement, any portion of the PVO that becomes vested and exercisable pursuant to § 2 or § 3(b), to the extent not previously exercised, shall remain exercisable through the end of the five (5) year period which begins on the later of the Vesting Date or the date of such Retirement, but in no event after the Expiration Date.
(d) Any portion of the PVO that becomes vested and exercisable pursuant to § 3(d) shall remain exercisable for the duration of the Exercise Period.
(e) This PVO shall expire on the date it has been exercised in full under this Option Agreement.
(f) This PVO shall expire on the Expiration Date to the extent it has not then been exercised.
(g) Notwithstanding anything in this Option Agreement to the contrary, if Optionee’s employment with SunTrust or a Subsidiary is Terminated for Cause, the PVO shall terminate and expire in its entirety, and all rights under this Option Agreement shall be forfeited, as of the end of the day before the date of Optionee’s termination of employment, regardless of whether this PVO was then vested or non-vested, and under no circumstances shall Optionee be entitled to exercise all or any part of this PVO after such expiration.
§ 5. METHOD OF EXERCISE. This PVO shall be exercised by properly completing and delivering the applicable form to the delegate specified by the Committee for option recordkeeping, indicating the number of shares of Stock to be purchased upon such exercise, together with the appropriate payment in full for the number of such shares to be exercised. Payment may be made in the form of a check made payable in accordance with the delegate’s payment instructions, or written confirmation of ownership of sufficient shares of previously acquired Stock or any combination of such payment methods as has been approved by the Committee. Such exercise shall be effective on the date such form and payment actually are delivered to SunTrust’s delegate; provided, however, if such form and payment are mailed to the delegate at the appropriate address by registered mail or by an overnight service, the related exercise shall be treated as effective on the date accepted for delivery by the post office or overnight mail service. Any previously acquired Stock which is designated as payment for the exercise shall be valued at its Fair Market Value (closing price) on the date the exercise is effective or, if the exercise is effective on a date other than a business day, at the Fair Market Value on the immediately preceding business day.
§ 6. WITHHOLDING. The Committee shall have the right to reduce the number of shares of Stock actually transferred to the Optionee to satisfy the minimum applicable tax withholding requirements, and the Optionee shall have the right (absent any such action by the Committee and subject to satisfying the requirements under Rule 16b-3) to elect that the minimum applicable tax withholding requirements be satisfied through a reduction in the number of shares of Stock transferred to the Optionee.
§ 7. NONTRANSFERABLE. No rights granted under this PVO shall be transferable by the Optionee other than by will or by the laws of descent and distribution.
§ 8. EMPLOYMENT AND TERMINATION. Nothing in the Plan or this Option Agreement or any related material shall give the Optionee the right to continue in employment with SunTrust or a Subsidiary or adversely affect the right of SunTrust or a Subsidiary to terminate the Optionee’s employment with or without cause at any time.
§ 9. SHAREHOLDER STATUS. The Optionee shall have no rights as a shareholder with respect to any shares of Stock under this Option Agreement until the Optionee has made payment in full for such shares and such shares have been duly issued and delivered to the Optionee, and no adjustment shall be made for dividends of any kind or description whatsoever respecting such Stock except as expressly set forth in the Plan.
§ 10. OTHER LAWS. SunTrust shall have the right to refuse to issue or transfer any Stock under this Option Agreement if SunTrust acting in its absolute discretion determines that the issuance or transfer of such Stock might violate any applicable law or regulation, and any payment tendered in such event to exercise this option shall be promptly refunded to the Optionee.
§ 11. SECURITIES REGISTRATION. SunTrust may request the Optionee to hold any shares of Stock received upon the exercise of all or part of this PVO for personal investment and not for purposes of resale or distribution to the public and the Optionee shall, if so requested by SunTrust, deliver a certified statement to that effect to SunTrust as a condition to the transfer of such Stock to the Optionee.
(a) TRANSFER OF EMPLOYMENT. A transfer of Optionee’s employment between or among SunTrust and Subsidiaries or between or among Subsidiaries shall not be deemed a termination of employment under this Option Agreement.
(b) CANCELLATION OF RIGHTS. Optionee’s rights under this Option Agreement may be canceled in accordance with the terms of the Plan.
(c) INCORPORATION OF PLAN. This Option Agreement shall be subject to all of the provisions, definitions, terms and conditions set forth in the Plan and any interpretations, rules and regulations promulgated by the Committee from time to time, all of which are incorporated by reference in this Option Agreement.
(d) GOVERNING LAW. The Plan and this Option Agreement shall be governed by the laws of the State of Georgia (without regard to its choice-of-law provisions), except to the extent superseded by federal law.
(e) NOTICES. Except as otherwise provided herein, any written notices provided for in this Option Agreement that are sent by mail shall be deemed received three (3) business days after mailing, but not later than the date of actual receipt. Notices shall be directed, if to Optionee, at Optionee’s address indicated by SunTrust’s records and, if to SunTrust, at SunTrust’s principal executive office.
(f) SEVERABILITY. If one or more of the provisions of this Option Agreement shall be held invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby and the invalid, illegal or unenforceable provisions shall be deemed null and void; however, to the extent permissible by law, any provisions which could be deemed null and void shall first be construed, interpreted or revised retroactively to permit this Option Agreement to be construed so as to foster the intent of this Option Agreement and the Plan.
(g) ENTIRE AGREEMENT. This Option Agreement (which incorporates the terms and conditions of the Plan) constitutes the entire agreement of the parties with respect to the subject matter hereof. This Option Agreement supersedes all prior discussions, negotiations, understandings, commitments and agreements with respect to such matters.
§ 13. DEFINITIONS. Whenever the following terms are used in this Option Agreement, they shall have the meanings set forth below. Capitalized terms not otherwise defined herein shall have the same meanings as in the Plan.
(a) CHANGE IN CONTROL AGREEMENT – means a change in control agreement by and between SunTrust and the Optionee.
(b) CODE – means the Internal Revenue Code of 1986, as amended.
(c) DISABILITY – means a disability within the meaning of Code Section 22(e)(3).
(d) PERFORMANCE LEVEL – means the level of performance achieved by SunTrust during a measurement period (generally, the Performance Period) based on the TSR Percentile for such period.
(e) PERFORMANCE PERIOD – means the period commencing January 1, 2009 and ending on December 31, 2011.
(f) RETIREMENT – means the voluntary termination of employment by the Optionee from SunTrust or its Subsidiaries on or after attaining age 55 and having completed five (5) or more years of service as determined in accordance with the terms of the SunTrust Retirement Plan. An Optionee who is vested in the SunTrust Retirement Plan benefit but terminates employment before attaining age 55 or completing at least five (5) years of service is not treated for purposes of this Option Agreement and the share of Stock subject to this PVO as terminating employment due to Retirement.
(g) SUNTRUST RETIREMENT PLAN – means the SunTrust Banks, Inc. Retirement Plan, as amended from time to time.
(h) TERMINATION FOR CAUSE OR TERMINATED FOR CAUSE – means a termination of employment which is made primarily because of (i) the Optionee’s willful and continued failure to perform his job duties in a satisfactory manner after written notice from SunTrust to Optionee and a thirty (30) day period in which to cure such failure, (ii) the Optionee’s conviction of a felony or engagement in a dishonest act, misappropriation of funds, embezzlement, criminal conduct or common law fraud, (iii) the Optionee’s material violation of the Code of Business Conduct and Ethics of SunTrust or the Code of Conduct of a Subsidiary, (iv) the Optionee’s engagement in an act that materially damages or materially prejudices SunTrust or any Subsidiary or the Optionee’s engagement in activities materially damaging to the property, business or reputation of SunTrust or any Subsidiary; or (v) the Optionee’s failure and refusal to comply in any material respect with the current and any future amended policies, standards and regulations of SunTrust, any Subsidiary and their regulatory agencies, if such failure continues after written notice from SunTrust to the Optionee and a thirty (30) day period in which to cure such failure, or the determination by any such governing agency that the Optionee may no longer serve as an officer of SunTrust or a Subsidiary.
Notwithstanding anything herein to the contrary, if the Optionee is subject to the terms of a Change in Control Agreement at the time of his termination of employment with SunTrust or a Subsidiary, solely for purposes this Option Agreement, “Cause” shall have the meaning provided in the Change in Control Agreement.
(i) TERMINATION FOR GOOD REASON – means a termination of employment made primarily because of (i) a failure to elect or reelect or to appoint or to reappoint Optionee to, or the removal of Optionee from, the position which he or she held with SunTrust prior to the Change in Control, (ii) a substantial change by the Board or supervising management in Optionee’s functions, duties or responsibilities, which change would cause Optionee’s position with SunTrust to become of less dignity, responsibility, importance or scope than the position held by Optionee prior to the Change in Control or (iii) a substantial reduction of Optionee’s annual compensation from the lesser of: (A) the level in effect prior to the Change in Control or (B) any level established thereafter with the consent of Optionee.
Notwithstanding anything herein to the contrary, if the Optionee is subject to the terms of a Change in Control Agreement at the time of his termination of employment with SunTrust or a Subsidiary, solely for purposes of this Option Agreement, “Good Reason” shall have the meaning provided in the Change in Control Agreement.
(j) TOTAL SHAREHOLDER RETURN or TSR – means a company’s total shareholder return, calculated based on the stock price appreciation during a specified measurement period plus the value of dividends paid on such stock during the measurement period (which shall be deemed to have been reinvested in the underlying company’s stock).
(k) TSR PERCENTILE – means the percentile rank of the TSR for SunTrust during the Performance Period relative to the TSR for the 24 companies listed on Appendix A (the “Peer Group”) during the Performance Period; provided, however, that for purposes of measuring the TSR Percentile: (i) the Committee reserves the right to make adjustments to the Peer Group based on developments that occur during the Performance Period, such as removing from the Peer Group, retroactively to the beginning of the Performance Period, any company no longer existing as an independent entity or which has announced it is being acquired; and (ii) the beginning and ending TSR values shall be calculated based on the average of the closing prices of the applicable company’s stock for the 20 trading days prior to and including the beginning or ending date, as applicable, of the Performance Period.

Performance-vested stock options and interest alignment.
This paper investigates the effects of performance-vested stock options (PVSOs) in aligning management interests and shareholder wealth. Using 4238 executive-level observations for 1383 executive directors from the largest 244 UK non-financial firms over the 1999–2004 period, we find that the use of PVSO schemes in executive compensation contracts is associated with greater interest alignment. The evidence also shows that PVSOs outperform traditional stock options (TSOs) in providing incentives. Moreover, the results suggest that difficult vesting targets negatively affect managers' choice of effort, resulting in the divergence of managers' and shareholders' interests.
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Performance-Vested Stock Options and Earnings Management.
30 Pages Posted: 21 Nov 2008.
Yu Flora Kuang.
affiliation not provided to SSRN.
Date Written: 2008-05.
This paper investigates the effects of performance-vested stock options (PVSOs) on the propensity of managers to engage in earnings management. Using observations from the 240 largest non-financial firms in the UK, I show that managers are more likely to engage in earnings management when they hold a larger proportion of their compensation in PVSOs. When categorizing PVSOs on the basis of their distance from the end of performance periods, the results show that managerial incentives to manage earnings mainly stem from PVSOs that are granted in prior years but within a performance evaluation period (i. e., PVSOs before vesting). Moreover, vesting targets influence the relationship between earnings management and PVSO compensation. The findings are consistent with the earnings smoothing hypothesis: confronted with more ambitious vesting targets, managers who are heavily loaded with PVSOs before vesting will report higher performance by generating greater accounting accruals, whereas in years with good performance, these managers will have incentives to reduce current reported performance by managing earnings downward so they can increase earnings as needed in the future.
Yu Flora Kuang (Contact Author)
affiliation not provided to SSRN.
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