In a volatile economy, rewards through employee incentive plans directly influence how organizations attract, retain, and motivate talent. This article examines the challenges and best practices in designing and administering incentive plans amid periods of market volatility. Explore key tax, valuation, and accounting considerations from our overview below.
Market Volatility: Key Drivers & Impact
Understanding the drivers of market volatility is important for businesses and investors seeking to interpret market behavior, manage risk, or make informed decisions. Policy shock is one of the most immediate and significant sources of volatility in 2025, with the implementation of tariffs or trade restrictions potentially disrupting trade flows, complicating corporate planning, and driving a rapid reassessment of supply chains and cost structures. Supply chain fragility is a challenge when dependence on global suppliers makes companies vulnerable to cost spikes and delays when tariffs hit key inputs. Other volatility drivers include market concentration, policy developments, and geopolitical uncertainty.
Some notable drivers of volatility in the past 30 years include the dot-com bubble when market participants bid up prices. Once sentiment shifts or earnings disappoint, valuations can contract rapidly, leading to significant drawdowns. Systemic risk, as revealed in the 2008 financial crisis, represents a deeper and more pervasive threat. Failures in credit markets, excessive leverage, and flawed risk models led to numerous institutional collapses and a global liquidity crisis. Exogenous shocks, or events that originate outside the financial system such as the COVID-19 pandemic, can disrupt economic activity, alter consumer behavior, and cause rapid policy responses.
Tax Implications: Navigating Section 409A & 83(b) Elections
Changes to incentive awards can create tax ramifications for employees and employers, as well as potential Internal Revenue Code (IRC) §409A violations for employees. For example, market volatility can result in stock options becoming “underwater,” where their fair market value (FMV) falls below their exercise price. In this event, options can be repriced so the exercise price is effectively lowered to reflect the current market value, but employers should approach this with caution. Stock options are exempt from §409A rules, but only if they meet certain requirements. Market volatility can increase the risk of options being granted below FMV and subject them to §409A compliance—a move that, in the event of noncompliance, is “extremely punitive” and results in immediate income inclusion of vested portions, which is subject to a 20% excise tax and a premium interest tax.
Risks & Benefits of Section 83(b) Elections for Restricted Stock Awards (RSAs)
Section 83 is the IRC section that dictates the timing of inclusion, and amount, of income (taxable compensation) for property that is transferred in connection with the performance of services, with the key determination being whether the property transferred is restricted or unrestricted.
Under the general rule of §83(a), the FMV of property will be included in gross income when it is transferred so long as it is not subject to a substantial risk of forfeiture, i.e., restricted. In other words, if there is a transfer of unrestricted property, the individual receiving the property will have taxable compensation in an amount equaling the FMV of the property on that date, less amounts paid to acquire it.
Restricted property, on the other hand, is typically subject to a vesting schedule, i.e., substantial risk of forfeiture, and not treated as taxable compensation under §83(a) on the grant date. Instead, gross income inclusion occurs on the vesting date and in an amount that equals the FMV on the vesting date, which could be higher or lower. There is an exception, however, known as the §83(b) election, which allows the recipient to choose whether it wants to have property taxed on the grant date as if it was not subject to forfeiture, or not make the election and wait until it vests. This decision to file the §83(b) election should be viewed as a gamble, particularly in a volatile market, as there are no credits, deductions, or other offsets if the value has decreased below the grant date value or if the shares are forfeited before vesting.
Valuation in Volatile & Tariff-Affected Markets
Volatility and tariffs can increase valuation complexity. Valuation methodologies, including income and market approaches, require adjustments to reflect uncertainty.
The income approach, often using the discounted cash flow method, evaluates a business’s expected cash flows based on management’s prospective financial information and applies a discount rate to convert them to a present value, accounting for associated risks. Key factors include cash flow reliability and discount rates, both of which are influenced by market volatility. Systematic risk (macroeconomic risk) and unsystematic risk (company-specific risk) are critical to consider, especially for businesses heavily affected by tariffs or other external factors. Dynamic scenario modeling is recommended to address uncertainties and support valuations.
The market approach typically involves applying market multiples to financial metrics like earnings before interest, taxes, depreciation, and amortization (EBITDA) or revenue, based on peer group benchmarking. In volatile markets, historical results may no longer reflect future expectations, necessitating adjustments to multiples and benchmarking. Granularity in peer group selection is emphasized, as companies with differing operational or sourcing characteristics may experience varying impacts. This approach requires careful evaluation of how market changes affect both the subject company and its peers.
The backsolve method, a form of the market approach that is commonly used in valuations prepared for §409A and/or Accounting Standards Codification (ASC) 718 purposes, derives equity value from actual transactions, such as preferred financing events. While rooted in real transactions, this method can become outdated in volatile markets, requiring adjustments to reflect current conditions. Key inputs like volatility and exit timing, e.g., an initial public offering or sale, must be reassessed to help ensure accuracy. In addition, minority discounts for lack of control and marketability, often based on quantitative models, are influenced by volatility and exit timing. Throughout all methods, peer group selection and scenario analysis are critical to help achieve fair and accurate valuations.
Accounting Implications of Incentive Compensation Adjustments
ASC 718 governs accounting for stock options, restricted stock, share-settled stock appreciation rights, employee stock purchase plans (ESPPs), and employee stock ownership plans. ASC 718 requires companies to calculate the fair value of stock options granted to employees and expense that amount over the service period (generally the vesting period) as a charge to the income statement with a corresponding credit to shareholders’ equity or a liability. Note that “fair value” under ASC 718 is an accounting measurement, which may differ from “fair market value” used for tax purposes.
Market volatility can also impact the effectiveness of equity awards as retention and motivational tools. For example, stock options carry more risk since they only provide value when exercised if the stock price exceeds the strike price. Options can go “underwater” when the market price falls below the exercise price, potentially removing all intrinsic value. Restricted stock units (RSUs) retain some value regardless of market fluctuations (unless the stock price drops to zero). ESPPs may become more attractive during market declines as employees can buy shares at lower prices, potentially positioning them well for future rebounds.
Market volatility can affect three types of equity classified awards: service, performance, and market. Companies may consider repricing options or modifying awards to maintain their incentive value, but these actions can trigger additional accounting, valuation, and tax considerations under ASC 718.
Businesses may consider modifying outstanding awards through equity restructurings, modifications when holders are no longer employees, replacement with a new award, and a change in participation thresholds for profit interest units. When a company modifies outstanding awards—such as repricing underwater options, canceling and replacing awards, or changing participation thresholds—ASC 718 requires measuring the fair value of the award both before and after the modification. Any increase in fair value is recognized as incremental compensation expense. For example, if options are repriced to a lower exercise price, the incremental value above the original grant is expensed in addition to the original amount. All modifications to incentive awards should be clearly disclosed in the financial statements, including the nature of the modification, the incremental compensation expense recognized, and any changes to vesting or classification.
Strategic Recommendations for Implementing & Managing Incentive Plans
- Have best practices for designing flexible, compliant, and motivating incentive plans.
- Recognize the importance of cross-functional collaboration between legal, tax, valuation, and accounting teams.
- Consider performance-based awards and equity alternatives like RSUs and phantom stock.
How Forvis Mazars Can Help With Long-Term Incentive Plan Design
Thoughtful incentive plan design calls for proactive planning and ongoing review, balancing short-term agility with long-term goals. Modifying incentive plans in uncertain times presents challenges, but companies don’t have to navigate periods of volatility alone. Close collaboration with accounting, tax, valuation, and legal teams can help your incentive plan management succeed. Engaging technical professionals early in the process can help you comply with ASC 718 and avoid unexpected financial or tax consequences. If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.
Watch our webinar recording for more insights, “Incentive Plans in a Volatile Market.”