Page 449 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 435

• The number of shares of a repriced stock option will count toward the maximum
number of shares under the approved plan and the maximum that may be awarded any
one individual. In other words, the number of shares is counted twice: the number in
the original grant and the number in the repricing.
• Investors will not support the action and may sue if the plan does not specifically
permit repricing.
• Employees not similarly protected in savings plans, stock purchase plans, and other
benefit plans will view this as a double standard.
• Those who exercised options before the drop in market price will seek something to
offset their paper losses.
• The public will view the action as one of excessive executive greed.
• The SEC requires the compensation committee to explain the reason for repricing
any grants of any executive officers listed in the proxy pay tables.
• FAS 123R requires a repriced option to be subject to fair-value grant-date accounting
on date of repricing regardless of when done.

Repricing may be more palatable if following conditions are met:
• Top executives are excluded.
• Performance hurdles or future higher prices are included.
• Exchanged shares are economically equivalent, thereby resulting in fewer shares
under option.
• The plan is approved by shareholders in advance of the action only if stock drops below
a stated percentage of affected options (e.g., 50 percent for a prescribed sustained
period of time such as 90 days) and the plan is good for a stated period of time (e.g.,
five years). The New York Stock Exchange ruled in 2003 that a stock plan that does not
specifically permit repricing is ruled as prohibiting the action.
In deciding whether or not one has a repricing issue, it is helpful to look at outstanding
options in relation to current stock price. In Table 8-22, we see the 10 years of outstanding
grants. If the current stock price were at $100, even though one grant is slightly below
market value, one would not consider repricing. But what if the fair market value were $50?
In this case, five grants are below market value. A generous approach would be to reprice
all those above $50; a more conservative approach would be to simply reprice those that
lost more than 50 percent of their market share. In this situation, only the $105 option
would be repriced.
Alternatives to repricing include the following: (1) do nothing on the belief that the stock
price will rise in time for the option to have value, (2) give an additional stock option or
restricted stock grant, (3) shorten the period until the next stock option grant, (4) permit the
sale of the stock option to a third party (e.g., a financial institution), (5) promise to grant a
new option six months and a day in the future, or (6) buy out the underwater option with a
restricted stock award and/or cash. Doing nothing is a very reasonable approach if the option
is not significantly underwater and/or there are a number of years remaining on the grant.
Buying out the underwater grant requires determining the ratio of canceled options to
the desired action. While one-to-one is easiest to explain, it is granting additional upside
opportunity because of the lower price. A compromise would be to average the number of
shares of the original grant with the number that would be the mathematical equivalent due
to the lower price. So instead of turning in ten options to receive one new option, the ratio