Underwater Options Exchange Should Exclude Executives, Maintain Value

February 9, 2009 (PLANSPONSOR.com) - A new analysis from Aon Consulting's Radford Surveys + Consulting found exclusion of board and named executive officers (NEOs) and a value-neutral exchange rate were design features of underwater stock option exchange proposals that figured most prominently in gaining approval.

Sixty-two percent of programs excluding board members and NEOs gained approval, compared to only 18% that included them. According to a press release, Radford found 60% of the mutual funds in this analysis voted against any program brought to them that included the board and NEOs.

Returning an equal or lesser award value to option holders as a result of the exchange clearly was a deciding factor to shareholders in the Radford study, as 54% of programs using approximate value-neutral exchange rates gained approval. Only 2% were approved that used a ratio (or ratios) that added value to the employee’s holdings as a result of the exchange.

The Radford research also found programs that reset vesting had an approval rate of 57%, compared to those that mapped vesting, which saw only an 18% approval rate.

Starting in 2008, institutional investor advisory firm RiskMetrics Group added to its voting guidelines that no options priced under the company’s 52-week stock price high should be eligible for exchange, as they have reasonable probability of coming back in the money in the foreseeable future, the press release said.

According to Radford’s analysis of historic voting patterns against the 52-week test, this feature is the least sensitive predictor of approval rates with 59% approval when programs comply and 41% approval when they do not.

Radford warned that more mature organizations that are largely held by institutional investors must be careful when using recent underwater option exchanges filed with the SEC as best practices benchmarks.

Mutual fund voting data for the study was provided by RiskMetrics Group’s Voting Analytics database. Radford combined these voting results with its proprietary database of underwater exchange design features gleaned from SEC tender offer filings.