Stock Option Repricing Plans Showing Signs of Comeback in Wake of Economic Crisis
By: SCOTT J. DORFMAN
October 2009
After almost a decade of dormancy, stock option repricing schemes have staged a comeback over the past year. With the global economic crisis and declining stock prices, many public companies have found that stock options previously issued to directors, executive officers, and other employees are now significantly “underwater,” or have exercise prices that are much higher than the market price of the underlying shares. Seeking to restore the “incentive” in their long-term incentive compensation plans, many public companies have recently initiated a repricing of previously granted stock options, a technique that was popular following the bust of the technology bubble in 2000-2002. According to one report, at least 100 public companies have repriced options in the last 18 months.
Option repricing schemes can take a number of forms, but can be roughly classified into three groups:
- Exchanges for Shares: Underwater options are cancelled and replaced with typically fewer shares of restricted stock or restricted stock units;
- Exchanges for Options: Underwater options are cancelled and replaced with typically fewer options with a lower grant date price; and
- Exchanges for Cash: Underwater options are cancelled and replaced with a cash payment.
In the case of exchanges for shares and exchanges for options, optionees typically receive fewer shares or options, respectively, because companies are wary of asking unhappy shareholders to approve one-for-one exchanges not available generally to all shareholders.
Repricing options can trigger a number of legal, accounting, and investor relations considerations for a public company, including the following:
Shareholder Approval
NASDAQ and the NYSE both require listed companies to receive shareholder approval for any option repricing scheme not explicitly authorized by the particular plan. If the plan itself authorizes option repricing without shareholder approval, a listed company may do so, but may face shareholder backlash from the decision. A leading proxy advisory service, RiskMetrics Group, recommends a vote against any compensation committee members who voted to approve an option repricing without shareholder approval. Companies should therefore exercise caution when attempting any option repricing without first seeking shareholder approval, even if allowed under the terms of the governing plan. RiskMetrics Group’s voting guidelines also provide that directors and “named executive officers” should be excluded from the repricing, and that the exercise price of the surrendered options be above the 52-week high for the share price.
Shareholders are generally not happy to approve option repricings that confer a benefit on employees not shared by all shareholders, since shareholders have seen the value of their shares decline as much as have option holders. Companies should consider conducting a vigorous investor relations campaign in connection with any option repricing, especially if the repricing will be done without shareholder approval.
Proxy Statement Disclosure
If shareholder approval is sought at either an annual or a special meeting of shareholders, a company must follow all of the proxy solicitation regulations found in Regulation 14A under the Securities and Exchange Act of 1934 (Exchange Act), including the proxy statement requirements found in Schedule 14A. At a minimum, this means disclosure of the material features of the underlying plan, and all non-employee director, executive officer, and employee holdings under the plan.
Tender Offer Rules
Any public company option repricing will likely also trigger SEC tender offer regulations, since the SEC views the option repricing essentially as an exchange of options for new securities (either new options containing revised exercise or vesting terms or new shares of restricted stock). These tender offer rules include Rule 13e‑4 under the Exchange Act, which requires the filing of a Schedule TO with the SEC, and Regulation 14E under the Exchange Act, which requires that tender offers remain open for at least 20 business days.
Accounting Rules
As a result of adoption of FAS 123R in 2005, the accounting treatment for option repricings has changed significantly. Companies previously structured repricings with a six-month interval between cancellation of existing options and replacement option grants, in order to avoid any mark-to-market impact. Now, with FAS 123R, the charge is fixed upfront and reflects only the incremental value of newly granted options over the cancelled underwater options. In a value for value exchange then (with fewer options or restricted stock shares being granted), the repricing is largely neutral in terms of accounting expense.
Takeaway
Companies that experienced a precipitous decline in share values may benefit from repricing its stock options in order to motivate key employees and to return the incentive aspect to long-term incentive compensation. Companies seriously considering instituting such a plan should prepare for resulting shareholder approval, proxy disclosure, accounting, and securities issues that are key to conducting a successful repricing.