Part 1: Option RepricingUnderwater stock options plans are yet another painful symptom of pandemic-related market volatility. Options granted during better times may have been pushed well out of the money, rendering them at least temporarily meaningless as an incentivizing tool. What’s more, today’s uncertain business environment is exactly when you need your key performers and proven leaders most, making the retention power of equity plans especially important.
In addition, underwater plans can cause financial headaches. They may cause you to take accounting charges for equity awards that are not providing value, and they’re an inefficient use of your equity reserves because they still count against your share plan limits, limiting the number of new awards you can grant.
So what can you do?
In an April 8 webinar, Shearman & Sterling’s Gillian Emmett Moldowan walked us through the implications of underwater plans and some of the alternatives your organization may have for repricing. An expert in compensation, governance and ERISA matters, Ms. Moldowan laid out the key considerations for handling underwater stock options in this time of crisis. You can watch the full webinar here or read more about Sherman & Sterling’s stock repricing guidance here. But here’s an overview.
Repricing your options
When a decline in your company’s stock price is the result of non-management forces such as the current public health crisis, one way to counteract the negative effects is to conduct a stock option repricing (aka option exchange) program. Under such a program, underwater stock options are surrendered by employees and replaced with options that have a lower exercise price. This can be accomplished in a number of ways.
Four approaches to stock option exchange
- Stock Option-for-Stock Option Exchange Programs. In this type of program, options are cancelled and replaced with new stock options that have an exercise price that is equal to or greater than the current market. The exchange ratio may be less than one-for-one, reducing an employee’s number of options but maintaining the value. You can also modify the term and vesting and forfeiture conditions of the new options.
- Stock Option-for-Other Security Exchange Programs. In this scenario, underwater stock options are exchanged for a different type of equity-based award, such as restricted stock, restricted stock units or phantom stock, typically on a value-for-value basis and often with additional vesting and forfeiture conditions.
- Cash Exchange Programs. In a cash exchange program or stock option buyout, a cash payment to employees may be made immediately or over time and may be subject to future vesting or forfeiture conditions.
- Stock Option Repricing Programs. In a pure stock option repricing program, you simply reduce the exercise price of underwater stock options by amending the option award without any exchange of rights.
How do you choose?
The table below outlines a few of the advantages and disadvantages of each approach identified by Sherman & Sterling; you can view the complete table here.
Certent can help
Some of the key regulatory and tax considerations along with ISS recommendations are explored in more detail here. For any path you pursue, you’ll need to consult with your legal, tax and accounting advisors. Or reach out to a Certent administrative services team member now.