Hurdle Options

A hurdle option, in contrast to a premium-priced option, permits exercise at the original market price on date of grant if the target price is reached. For example, if the Monsanto options had been hurdle options, once the $90-a-share price was achieved the options would be exercisable at $60, the assumed market price on date of grant. Thus, once the hurdle is achieved, the hurdle option gives the executive the same economic benefit as if there had been no hurdle. Generally this would mean the spread between the price on the date of grant ($60 in this example) and the price on date the option is exercised.

An accounting rule requires that, in order to avoid a charge against earnings, a hurdle option must be fully vested at some point during the option term. Otherwise, there is a charge against earnings for growth in value from the date of option grant to the date of option exercise. Put another way, if the hurdle is a condition to vesting, there is a charge against earnings but if achievement of the hurdle simply accelerates vesting and exercisability, which would occur in any event after continued employment for a specified term, there is no charge against earnings. 3

As a result of the accounting rule, employers granting hurdle options frequently have provided for vesting of a hurdle option shortly before the end of the option term (typically a 10-year term). If the hurdle price is achieved, the vesting and exercisability accelerate. As just explained, acceleration does not cause a charge against earnings.

Premium-priced vs. hurdle options: values equated. A company considering a premium vs. a hurdle option program may provide for equivalent value in the original grant. Obviously the premium-priced option will require more shares assuming the same targets as the hurdle option.

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