Underwater Options Lead Tech Companies To Alternative Pricing Strategies

March 7, 2003 (PLANSPONSOR.com) - High technology companies have turned to a number of different solutions to maintain the vitality of their stock option programs in an environment swamped with out-of-the money stock options.

The supplemental option grant was the most frequently applied strategy to address the issue of underwater options – those with a strike price higher than the current price of the underlying equity.   Overall, 70% of the high technology companies with underwater options utilize this approach, according Buck Consultant’s study “Underwater Stock Option Exchange Programs in High Technology.”

Additionally, nearly one-third of this group used a supplemental grant more than once.   However, the stock market’s continued decline led to many companies exhausting their ability to grant supplemental options without resolving the problem of underwater stock options.

A majority of companies still seeking solutions to a plethora of underwater stock options used one or more option exchange programs, in which option holders voluntarily exchange underwater options for alternatively priced shares.   Exchange programs remove a large number of underwater options from overhang, replacing them with new, on-the-money shares.   The justification for the corporate investment in exchange programs is the expectation that, as the economy improves, these revitalized equity interests will enhance the company’s recovery, according to Buck’s study.

Re-Granting Options

The survey examined 71 such exchange programs executed between April and December 2002 and found 94% used the cancel/delayed option re-grant, in which optionees receive new options after the six-month-and-a-day waiting period.   Companies tend to gravitate to this method to avoid an immediate earnings charge.

Buck pointed out that the exchange programs were designed to be sensitive to the concerns of investors and regulators.   Particularly, larger companies showed a heightened sense of awareness as only 43% included officers in exchange programs, only 29% offered a one-for-one exchange rate and the vast majority (71%) reset stock option vesting schedules.

The study consisted of two parts.   The first part was conducted among high technology companies participating in three Buck Consultants flash surveys between the winter of 2000 and the spring of 2002.   The second included companies that filed option exchange programs with the US Securities and Exchange Commission (SEC) between April and December 2002 representing six high technology industries:   telecommunications, semiconductors, networking, hardware, Internet, and software/software services.   Fifteen percent of the participants had revenues exceeding $1 billion; two-thirds had revenues less than $250 million.