No Lifeline for Underwater Options

Repricing proposals for underwater options likely will receive a chilly response from shareholders.

In the two years following the Internet bubble burst, some 400 U.S. public companies offered to buoy underwater employee stock options by exchanging them for something of value, including new options with a lower strike price.

Don’t expect a repeat performance, even with close to 100 percent of Fortune 500 CEOs’ stock options underwater at press time. The restive climate among shareholders and their advisory services likely will produce fewer proposals and mostly “no” votes for so-called repricings, say compensation attorneys and consultants. “We’re expecting to see a flood of these proposals come spring, but I’d be surprised if the total [approved] went to even half the levels of 2001–2003,” says Alexander Cwirko-Godycki, research manager at Equilar, which tracks options values and exchange programs. Along with the resistance from shareholders, he notes, companies now have more-diversified equity programs so that options aren’t as big a part of compensation as they once were.

According to Watson Wyatt, about 60 companies proposed options-exchange programs in 2008; most of them in the fourth quarter. What’s the tipping point? “On average, we’re seeing that once the stock price has dropped by about two-thirds [from three-year highs], that’s when companies feel the stress and take action,” says Watson Wyatt senior consultant Jim Scanella, who cites his firm’s study of 36 large companies that repriced options in 2007 and 2008. The range was wide, however, with some companies launching programs when the stock was only 50 percent down and others waiting for a 90 percent hit.

Many companies are already taking steps to make the programs more palatable to shareholders. While more than 60 percent are offering new options at a lower strike price in exchange for the underwater ones, to balance investor interests many are also reducing the number of options granted (hence reducing their potential dilution effect) and extending vesting periods, according to Equilar. Likewise, another 20 percent are offering restricted stock units, but generally in fewer numbers than options, to reduce overhang.

At least one company, $2.7 billion Yellow Pages publisher R.H. Donnelley, is also imposing some performance contingencies on the options replacements it doles out to executives. Senior management, including CFO Steven Blondy, will not be able to cash in any of their new stock-appreciation rights (SARs) until three years have passed and the stock price (now trading well below $1) hits $20. With shareholders complaining that “they didn’t have the alternative to reprice their shares,” says Blondy, “the performance hurdles became an essential element in securing [their] approval.”

Then again, CFOs may not have the luxury of worrying about whether or not to take part in an exchange. About 60 percent of current programs include executives, but that number is likely to taper off, says Cwirko-Godycki, since “excluding them is one of the easiest ways to win shareholder approval.”


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