Page 448 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

434 The Complete Guide to Executive Compensation

(i.e., 100 times $110). Another variation would be to grant them as freestanding equivalents
not attached to any form of stock, payable for a stated period of time. Alternatively, the right
could be for paid in cash for each unexercised share—in this case $10,000 (i.e., 10,000 $1).
A variation to the annual grant is the mega-grant, typically a pull-forward of future
grants. For example, a company with a practice of annual grants might believe the stock is
due to increase dramatically over the next several years. Therefore, rather than grant the
CEO 45,000 shares (see Table 8-15) with additional grants each year thereafter, the decision
might be to grant 135,000 shares (i.e., three times the 45,000) and not make another grant
until three years from now. A more aggressive action would be to grant 225,0000 shares and
make no additional grants for another five years. A range of three to five times the annual
grant is representative. The greater the pull-forward, the greater the potential opportunity,
but the risk is also greater that there will not be a lower price opportunity in the future.
Some companies choose to make mega-grants without considering them pull-forwards of
future grants. One rationale would be because a number of earlier grants are “underwater”
(i.e., the option price is above the market price).
A cancel-and-reissue, or repricing, is another action focused on negating the underwater
stock option. Rather than grant an additional option, the company acts to cancel outstanding
underwater options and replace them with new grants at the current lower prices. In a true
reissue, one expects the original expiration date to be in effect. A more liberal approach
would be to restart the clock on a new 10-year period. The number of shares could be the
same or reduced by some formula to an equivalency value based on the lower price. In other
words, the present value at time of the original grant could be revisited using current price
and remaining option period.
Another more liberal approach would argue for a higher number of shares (even assum-
ing the same dollar per share increase over the coming 10 years) than was projected when
the earlier option was extended. The increase would be based on recouping of lost time.
For example, if an option was extended at $50 a share five years ago and the market price is
currently $25, it might be decided to give twice as many shares since there are only five years
left on the option.
The arguments for repricing include the following:
• Repriced options are of little if any incentive value to the optionee since they are
below current market price.
• Repriced options increase the hold on executives otherwise likely to be lured away by
other employment opportunities.
• If fewer replacement options are granted, it will reduce the number of shares out-
standing.
The disadvantages of repricing include the following:
• Repriced options remove or significantly reduce the downside risk that is supposed to
balance upside potential in incentive pay, actually rewarding optionees for lower
prices.
• They protect the optionees, but not the shareholders, from paper losses.
• They create a precedent for future bear markets (i.e., how does one not repeat the
action under similar circumstances?)
• They decrease corporate cash flow and increase EPS dilution because the proceeds,
being less, buy back fewer shares.