10.7 Compensation Arrangements
An acquiree in a business combination may have agreements in place to provide
specified employees with additional compensation
predicated upon a change in control of the
acquiree. Such arrangements could have been
established either before or after the
negotiations began for the business combination.
When determining whether the acquirer should
account for these arrangements as part of the
business combination or separately as
compensation, entities must use judgment and
consider the specific facts and circumstances as
discussed below and in Section 10.2. However, if a business
combination results in additional compensation
arrangements payable to the acquirer’s employees,
these payments are always accounted for as
compensation costs in the acquirer’s financial
statements.
10.7.1 Arrangements to Pay an Acquiree’s Employee Upon a Change in Control
Arrangements may be established with the objective of retaining one or more of
the acquiree’s employees until the acquisition
date and possibly for a defined period thereafter.
Such arrangements — often referred to in practice
as “stay bonuses,” “change in control payments,”
or “golden parachutes” — may also provide
additional compensation for performance related to
the business combination or compensate employees
who are terminated after the combination.
Arrangements to pay an
acquiree’s employees upon a change in control must
be assessed to determine whether they should be
accounted for as part of or separately from the
business combination. In assessing the substance
of an arrangement, an entity should consider the
factors listed in ASC 805-10-55-18 (i.e., “[t]he
reasons for the transaction,” “[w]ho initiated the
transaction,” and “[t]he timing of the
transaction”; see Section 10.2 for
discussion) to determine whether the arrangement
should be accounted for as part of, or separately
from, the business combination. See Section
10.4.3 for more information about
making that determination. Arrangements to pay an
acquiree’s employees upon a change in control that
are determined to be separate from the business
combination represent compensation cost of the
acquirer. If no future service is required, the
acquirer should recognize compensation cost on the
acquisition date. There may also be circumstances
in which a payment needs to be allocated between
the portion attributable to precombination
services and postcombination compensation
cost.
ASC 805-10-55-34 through 55-36 provide an example of a contingent payment to an
acquiree’s employee:
ASC 805-10
Example 4: Arrangement for Contingent Payment to an Employee
55-34 This Example illustrates the guidance in paragraphs 805-10-55-24 through 55-25 relating to contingent payments to employees in a business combination. Target hired a candidate as its new chief executive officer under a 10-year contract. The contract required Target to pay the candidate $5 million if Target is acquired before the contract expires. Acquirer acquires Target eight years later. The chief executive officer was still employed at the acquisition date and will receive the additional payment under the existing contract.
55-35 In this Example, Target entered into the employment agreement before the negotiations of the combination began, and the purpose of the agreement was to obtain the services of the chief executive officer. Thus, there is no evidence that the agreement was arranged primarily to provide benefits to Acquirer or the combined entity. Therefore, the liability to pay $5 million is included in the application of the acquisition method.
55-36 In other circumstances, Target might enter into a similar agreement with the chief executive officer at the suggestion of Acquirer during the negotiations for the business combination. If so, the primary purpose of the agreement might be to provide severance pay to the chief executive officer, and the agreement may primarily benefit Acquirer or the combined entity rather than Target or its former owners. In that situation, Acquirer accounts for the liability to pay the chief executive officer in its postcombination financial statements separately from application of the acquisition method.
In accounting for the acquisition, the acquirer will need to assess whether to
recognize amounts that have been determined to be
part of the business combination as part of the
consideration transferred or as a liability
assumed.
If the acquirer issues cash, other assets, or its equity instruments to settle
the acquiree’s awards that were equity-classified
in the acquiree’s precombination financial
statements, the portion determined to be part of
the business combination represents consideration
transferred since the acquiree’s employees were
owners of (or increased their ownership in) the
acquiree as a result of the arrangement.
By contrast, if the acquirer issues cash, other assets, or its equity
instruments to settle a bonus arrangement (e.g.,
stay bonus) with the acquiree’s employees or to
settle the acquiree’s awards that were
liability-classified in the acquiree’s
precombination financial statements, the portion
determined to be part of the business combination
would be treated in the acquisition accounting as
a liability assumed.
If arrangements to pay an acquiree’s employees upon a change in control are
settled in cash or in other assets after the
acquisition date rather than at the closing of the
business combination, the acquirer would need to
recognize a liability in its acquisition
accounting for the portion determined to be part
of the business combination. In the acquisition
accounting, the nature of that liability as either
consideration transferred or a liability assumed
should be determined on the basis of the analysis
described above.
10.7.2 Dual- or Double-Trigger Arrangements
An employment agreement entered into before negotiations began for the business
combination may include terms that require a
payment or accelerate vesting upon (1) a change in
control and (2) a second defined event or
“trigger,” which is why such provisions are
commonly called “dual trigger” or “double trigger”
arrangements. The second defined event is
generally the separation of the employee from the
acquirer and might be limited to involuntary
terminations or might also include resignation of
the employee in specified conditions (sometimes
referred to as “good reasons”) such as:
-
A demotion or significant reduction in the employee’s duties or responsibilities after the acquisition date.
-
A significant reduction in the employee’s salary or compensation after the acquisition date.
-
The relocation of the employee’s job site beyond a specified radius after the acquisition date.
The objective of such employment agreements, which are typically entered into before negotiations have begun for a business combination, is generally to obtain the employee’s services. While the three factors in ASC 805-10-55-18 (i.e., “[t]he reasons for the transaction,” “[w]ho initiated the transaction,” and “[t]he timing of the transaction”) might indicate that the payments should be accounted for as part of the business combination, such arrangements are generally accounted for separately from the business combination. This is because the decision to effect the second trigger (i.e., the employee’s involuntary termination or voluntary termination for “good reason”) is under the control of the acquirer and is therefore presumed to be made primarily for the acquirer’s benefit (e.g., to reduce cost by eliminating the unneeded employee).
Example 10-18
Dual- or Double-Trigger Arrangement Involving the Termination of Employment
Company A acquires Company B in a transaction accounted for as a business combination. Company B has an existing employment agreement with its CEO that was put in place before negotiations began for the combination. Under the agreement, all of the CEO’s unvested awards will fully vest upon (1) a change in the control of B and (2) the involuntary termination of the CEO’s employment within one year after the acquisition date.
Before the closing, A determines that it will not offer employment to the CEO
after the combination has been completed. Thus,
both conditions are triggered, and the vesting of
the CEO’s unvested awards is accelerated upon the
closing of the acquisition.
The decision not to employ B’s former CEO was under A’s control and was made for
A’s benefit (i.e., to reduce costs). Therefore, A
should recognize the compensation cost related to
the accelerated vesting of the unvested awards in
its postcombination financial statements and not
as part of the business combination.
Example 10-19
Dual- or Double-Trigger Arrangement in Which Employee Resigns for “Good Reason”
As in the example above, Company A acquires Company B in a transaction accounted
for as a business combination, and B has an
existing employment agreement with its CEO.
However, in this example, the agreement provides
that all of the CEO’s unvested awards will fully
vest upon (1) a change in the control of B
and (2) either the involuntary termination
of the CEO or the voluntary departure of the CEO
for “good reason” within one year after the
acquisition date. The agreement specifies that a
significant reduction in job responsibilities
would be a good reason. After the acquisition
date, B’s CEO will not assume the role of CEO of
the combined entity but instead will be assigned a
position with reduced responsibilities. In
response, B’s CEO will resign upon the change in
control.
The decision to reduce the responsibilities of B’s former CEO after the acquisition date is within A’s control. Therefore, A should recognize the compensation cost related to the accelerated vesting of the awards in its postcombination financial statements and not as part of the business combination.
10.7.3 Arrangements to Reallocate Forfeited Awards or Amounts to Remaining Shareholders/Employees
An acquirer may issue share-based payment awards to a group of shareholders of
the acquiree, all of whom become employees of the
combined entity with such awards subject to
vesting based on continued employment. The awards
may be placed in a trust by the acquirer on the
acquisition date. Such arrangements are sometimes
referred to as “last man standing” arrangements
because any forfeited awards must be reallocated
to the remaining participants in the group. Some
arrangements may not specify what happens if none
of the participants are still employed by the
acquirer at the end of the term; however, since
these arrangements typically encompass many
employees, it would be unlikely that none remain.
Other arrangements may specify that the amounts
revert to the acquiree’s former shareholders if
none of the participants are still employed at the
end of the term.
In his remarks at the 2000 AICPA Conference on Current SEC Developments, then SEC OCA Professional Accounting Fellow R. Scott Blackley provided the following example of such an arrangement:
For illustration, consider an example business combination where a company acquires another enterprise, XYZ Company, for cash and stock. All of the shareholders of XYZ Company are also employees. The acquiring company expects and desires to have the employee shareholders of XYZ Company continue as employees of the combined companies. Accordingly, of the shares issued to the shareholders of XYZ Company, a portion is held in an irrevocable trust, subject to a three year vesting requirement (“forfeiture shares”).
The forfeiture provision requires that if, prior to vesting, a shareholder resigns from employment or is terminated for cause, the shares held in the trust allocable to the employee shareholder be forfeited. Additionally, any shares actually forfeited are reallocated to the remaining employee shareholders based on their remaining ownership interests such that all of the forfeiture shares in the trust will ultimately be issued.
Mr. Blackley said that in this scenario, the SEC staff concluded that “the forfeiture shares must be accounted for as a compensation arrangement.” He noted that the staff placed “significant weight” on the shares’ vesting on the basis of continued employment even though the amount of consideration was fixed because it would not be returned to the acquirer under any circumstances. Although Mr. Blackley made these remarks before FASB Statement 141(R), as
codified in ASC 805, was issued, we believe that they remain relevant.
Therefore, in an arrangement in which share-based payment awards are issued to a group of shareholders of the acquiree, all of whom become employees of the combined entity on the basis of a requirement to continue employment, the forfeiture and subsequent redistribution of the awards are accounted for as (1) the forfeiture of the original award and (2) the grant of a new award. That is, the acquirer would reverse any compensation previously recognized for the forfeited award (on the basis of the original grant-date fair-value-based measure) and then recognize compensation for the new award (on the basis of the fair-value-based measure on the date the award is redistributed) over the remaining requisite service period.
Example 10-20
Arrangement to Reallocate Forfeited Awards to Remaining Shareholders/Employees
On January 1, 20X1, Company A acquires Company B and, as part of the acquisition agreement, grants each of B’s 10 shareholders/employees 100 new share-based payment awards that vest at the end of five years of service (cliff vesting). The grant-date fair-value-based measure of each award as of the acquisition date is $10.
The terms of the award state that if employment is terminated before the end of five years (i.e., the vesting date), the employee’s awards are forfeited and redistributed among the remaining employees within the group.
The total grant-date fair-value-based measure of the awards as of the acquisition date is $10,000 (10 employees × 100 awards × $10 grant-date fair-value-based measure), which A recognizes in the postcombination financial statements as compensation cost over the five-year service period ($2,000 per year). On December 31, 20X3, two employees in the group terminate their employment and forfeit their awards, which are then redistributed to the eight remaining group members. The fair-value-based measure of each redistributed (i.e., new) award is $12 on the date the awards are redistributed.
On December 31, 20X3, A should reverse $1,200 of previously recognized
compensation cost (2 employees × 100 awards × $10
grant-date fair-value-based measure × 60% for 3
out of 5 years of services rendered) corresponding
to the forfeited awards. Company A should continue
to recognize $1,600 in annual compensation cost (8
employees × 100 awards × $10 grant-date fair value
÷ 5 years) over each of the remaining two years of
service for the original awards provided to the
remaining employees. In addition, A should
recognize $1,200 in additional annual compensation
cost (200 awards × $12 grant-date fair-value-based
measure ÷ 2 years of remaining service) over each
of the remaining two years of service for the
redistributed awards.
In some cases, payments to the shareholders/employees may be made in cash rather than forfeitable shares. We do not believe that the form of the payment affects the conclusion that such arrangements are based on continued employment and therefore should be accounted for as compensation and not as part of the exchange for the acquiree.