The current global stock market decline has left a large number of employee's world wide with equity awards that have a diminished or zero value. This has happened before. In the dot.com 'revolution' offering share options became an increasingly popular means of recruiting and retaining the best employees in the late 1990s. In the immediate aftermath of the stock market turmoil in 2000/2001, some companies changed their equity compensation packages to include other types of share incentives rather than share options. Set out below are the key choices available to employers in dealing with underwater options in a volatile market.

What is an underwater option?

A share option is a right granted by a company to its employees / directors to acquire shares at a pre-determined price (option price). Share options can be divided into:

  • Approved share option schemes – approved by the Revenue Commissioners under the Taxes Consolidation Act 1997.
  • Unapproved share options – all other share option schemes. Share options are underwater when the option price is higher than the market value of the shares.

What choices are available to a company with underwater options?

With regard to the solutions to underwater options, it is important to note that "one size does not fit all" and the most appropriate solution will depend on a variety of factors including the type of company; why the options are underwater; the rules of the relevant option plan; accounting and revenue reporting implications and whether the company is private or a public listed company.

The solutions are as follows:

  • Do nothing (and/or redress perceived imbalance by granting more options)
  • Re-price existing options
  • Allow an exchange of the existing options i.e. surrender and regrant
  • Replace options with different share based incentives
  • Do a combination of these.  

Other issues to consider:

In addition to the solutions available in dealing with underwater options, a number of other issues need to be considered, including:

  • Private Companies – in matters of remuneration, unquoted, private companies have much more flexibility than public listed companies and can amend existing awards more easily.
  • Redundancies – companies should ensure that they have a clear understanding of how their share plans work in the event of redundancies. Not all plans are drafted in the same way and it is not uncommon for redundancy to be treated in different ways under different plans.
  • Takeovers / Intra Group Reorganisations – As with redundancies, companies should know what happens under their share plans in the event of a takeover or reorganisation. Plan rules vary and companies should be careful not to inadvertently trigger change of control provisions or lose any tax benefits.  

Summary

Share plans remain an important tool for incentivising employees both at all employee and executive levels because:

  • They align the interests of shareholders and employees.
  • They assist cash poor companies with their remuneration packages.
  • Share options are low risk for employees.
  • Revenue approved schemes can provide worthwhile tax breaks for both employees and employers.