June 20, 2020 Executive Compensation Executive & Director Pay Design Articles

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Executive & Director Pay Design

How Do Options Exchange Programs Work? A "First Question"

Learn if you can do anything about deep underwater stock options. Use our checklist which includes suggestions on how to best respond to your shareholders and move your company in the right direction:

Concept

Provide opportunity for employees to trade in underwater options for a smaller amount of new options at current market price

Objectives

  • Increase incentive value without taking on additional accounting cost
  • Decrease overhang from equity awards

Challenges

  • The exchange reduces upside opportunity, and you can only do it once; so, when’s the right time to act?
  • Proxy advisors expect option exchanges to follow a set of rules and guidelines
  • Timing. If you want to execute outside of normal annual meeting timing, you’ll need to call a special meeting
  • You should talk with shareholders prior to the vote [market data about prevalence and vote recommendations and results]
  • Senior executives typically do not participate
  • Options that are very far out of the money and/or have little time until expiration may have very little theoretical value, requiring a very high exchange ratio
  • Communicating to employees so they can make an informed decision requires a strong communications plan

Initial Checklist

  1. Inventory the characteristics of outstanding option awards (e.g., remaining term, strike price, number outstanding) and assess which make sense given that the exchange would occur at the earliest following the next annual meeting of shareholders
  2. Proactively engage shareholder and proxy advisors
  3. Analyze impact on share reserves, shareholder outcomes, and employee economics
  4. Prepare shareholder proposal including program rationale and mechanics

Need some more help?

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