Underwater Life

How companies are dealing with out-of-the-money stock options.

Pity the legion of stock-option holders whose dreams of sudden wealth have sunk to the bottom of the sea. Their pain is exceeded only by that of the shareholders, who saw the value of their actual stock in hand fade away. Is there a way to create new incentives for employees without jarring shareholders with a standard repricing? Some companies think so, and are considering voluntary option exchanges in which employees swap their options for fewer grants that have a more realistic strike price.

Old-fashioned repricings have become unpopular since the Financial Accounting Standards Board began requiring companies to take a charge against earnings each quarter on the difference between the new strike price and the fair value of the shares. But some companies believe that in order to keep people, they have no other choice. For example, Barnesandnoble.com repriced this year, cutting the strike price for nearly 6 million options from $16.15 to $8, and says the repricing was a competitive necessity.

A few companies, however, are exploring the creation of an option-exchange program that gives employees a fresh start with their grants. The idea is driven by the notion that even deeply submerged options have value, especially if there is high volatility and a lengthy expiration date. Chicago-based Navigant Consulting Inc., for example, a company whose own stock nosedived from a high of $54 to under $5 after a management shakeup and allegations of improper accounting, announced recently that it would allow its employees to trade in their old options for fewer shares and a more reachable strike price that reflects a five-day average of the stock. The company touts the plan as a win-win. Employees’ hopes are revived, and shareholders see much less dilution.

Companies that go the exchange route still have a charge to earnings to worry about, says Robert Waxman, an accounting expert at Corporate Finance Advisory, in New York. “You’re not giving employees more than they already had,” says Waxman. “But because of the reduced number of shares, the earnings exposure will be much smaller.”

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