Tom Twitlet, president of Twitlet Corporation, is considering establishing a compensatory share option plan for the company’s 20 top executives. Tom desires 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 is concerned about how to specify and account for the terms of the plan, and has asked for your advice.

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