Tom, Twitlet, president of Twitlet Corporation, is considering establishing a compensatory share option plan for the company's 20 top executives. Tom wants to set the terms of the plan so that the number of options the executives can exercise increases based on a specified increase in the company's future earnings. Tom want to make sure that the plan cannot be manipulated but, in addition, it should properly motivate the executives to stay with the company and make it successful. Give the concern, he wants to know how the increase in earnings should be specified. Shold it be a dollar amount or a percentage change, and should the change in earnings be compared to the company's past results or against industry results? He also is interested in understanding how to determine the service period of the plan. Finally, Tom wants to understand the accounting for the plan and how it will affect the company's financial statements.

Prepare a memo to Tom that briefly explains the issues involved in specifying the terms used in the plan and accounting for the terms of this type of compensatory share option plan.