The Advisors' Blog

Here’s an excerpt from the intro of this Latham paper “Paying the Premium: An Alternate Approach to Repricing Underwater Options”:

In the current uncertain economic landscape, stock option repricing and exchange programs have once again resurfaced as commonly explored alternatives to alleviate the competitive compensation and retention headwinds faced by companies with a significant number of underwater options. However, the inherent complexities and potential limitations of these programs often create roadblocks or require commercial compromises that impair the program’s effectiveness in achieving the desired incentive and retention goals.

Specifically, the memo goes on to address tender offer considerations for traditional stock option repricings and exchanges:

An option exchange program typically requires option holder consent and constitutes a tender offer under applicable US securities rules because option holders are required to make an investment decision when electing whether to participate in the exchange. An option repricing can also trigger the tender offer requirements where option holder consent is required, such as if the repricing is tied to the imposition of additional or extended vesting conditions on the repriced options.

The memo notes that companies “grappling with these issues may want to consider a novel approach to addressing underwater options,” and describes the “premium” approach, which “delays the availability of the repricing unless and until certain new exercise conditions are satisfied (e.g., continued employment through a later date).” 

[A]n alternate approach to option repricing is available through which repriced options remain subject to a higher exercise price (or a “premium” exercise price) applicable to exercises occurring prior to the expiration of a specified vesting or retention period (the “premium period”), which may be longer than the original vesting period and/or contain other new vesting conditions.

As with a traditional option repricing, under this approach the exercise price of an underwater option is reduced to the fair market value of the company’s stock on the effective date of the repricing (thus locking in the availability of the repricing-date fair market value). However, if the option holder exercises the repriced option or terminates service, in either case, prior to the expiration of the premium period, the option holder does not benefit from the repricing and must instead pay the premium exercise price per share (i.e., an amount up to the original exercise price) upon exercise.

This approach effectively imposes a new vesting schedule on the repriced option, but typically can be implemented by the plan administrator unilaterally since it conveys only a benefit (i.e., the reduced exercise price after the satisfaction of the premium period) and has no material adverse impact on the option as it currently exists.

– Meredith Ervine