Portfolio

When company stock options turn sour

Amarpal S. Chadha | Updated on January 08, 2013

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Stock options are long-term reward programs and should not be seen as an overnight billionaire program.

Your compensation package four years ago included an option to buy your company’s stock or a stock option plan. But now that its time to exercise your option, you find that the stock is far cheaper in the market. In such a case, don’t despair. Companies do have practices in place to deal with such a situation.

The term used in such situations is underwater stock option, which is when the exercise price of an option is higher than the prevailing market price of the company’s stock.

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Put in simple words, you can buy a particular share from the stock market for a price lower than the one you have been offered through the stock option plan. Let’s assume that you have been offered stock options with an exercise price of Rs 10 per option/share. And that at the time when you exercise your options, your company’s shares are traded in the stock exchange for Rs 7. This means that if you exercise your options you have to pay Rs 10, while you could buy the same share from the stock market for Rs. 7.

When the stock options go underwater, it will defeat the very purpose of issuing the stock option to employees — rewarding employees for their past and future performance.

Most companies take precautionary measures to reduce the impact of underwater stock options. Some measures adopted are re-pricing the exercise price, options for lesser number of shares/restricted stocks, options for cash and so on. Under the re-pricing model, companies will fix a new exercise price which will be at least equal to - if not less than - the current market value of the shares. The company may offer fewer shares or restricted stocks or even cash in place of large number of options offered in the past.

Whichever recovery measure the company may choose, it will need to ensure that the interest of the ultimate stakeholders is not negatively impacted. Some companies do the re-pricing of those options which are allotted to middle and lower level management, leaving out the top and senior level people.

A large number of Indian companies have their options underwater and they have taken measures which, though not eliminating the effect completely, at least attempts to reduce the impact. In the past, companies such as Jain irrigation, India Infoline, Dish TV have re-priced their stock options.

Whether companies take recovery measures or not and whichever method they adopt towards recovery, they should clearly communicate the same to the employees. Companies need to educate the employees that stock options are long-term reward programs and should not be seen as an overnight billionaire program.

Next, if re-pricing of options is done for every swing in the market, it may send out a wrong message to the employees that whatever may happen to the market, their profit is guaranteed, which may not be the best thing to do. Hence, any recovery measure which the company may choose to adopt requires regular monitoring of the situation and good planning.

Last, but the most challenging task in the entire process of tinkering with the stock option plan could be to convince the ultimate stakeholders. Any wrong move which may seem to give top executives a better deal will definitely not go down well with the shareholders. Hence, it is of utmost importance to gain the confidence of the shareholders before making any changes to the option plan.

Stock options are long-term reward programs and should not be seen as an overnight billionaire program.

(The author is Tax Partner, Ernst & Young. )

Published on January 05, 2013

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