Since the start of 2008, at least 97 companies have proposed or completed plans that would exchange underwater stock options, according to research firm Equilar Inc. The companies swap options for ones with lower prices, increasing employees chances of making a profit.
The trend creates a dilemma for investors. The option exchanges lift employee morale and help retain valuable workers. At the same time, the programs dont seem fair to some investors, since regular shareholders dont get the same deal. They can also dilute the stocks value when employees exercise their options.
“I remain skeptical about these types of proposals for obvious reasons,” said Paul Wick, a fund manager at J&W Seligman & Co., part of Ameriprise Financial, which had $372 billion under management at the end of 2008. “Theres no way for public investors to reboot and reprice their entry when they bought shares.”
More than 70 percent of the largest 500 companies had options with exercise prices higher than their market price in mid-February, according to Redwood City, California-based Equilar. Companies ranging from Williams-Sonoma Inc. to Google Inc. have repriced employee stock options or announced plans to do so.
Pent-Up Demand
“Were seeing a lot of pent-up demand for options exchanges,” said Patrick McGurn, special counsel at proxy adviser Institutional Shareholder Services, a unit of New York- based RiskMetrics Group. “Were seeing some of the first ripples hitting the shore, but sooner or later theres going to be a tsunami.”
The Standard & Poors 500 Index has dropped 15 percent in 2009, the worst start to a year its eight-decade history, following a 38 percent decline in 2008 that was the steepest annual retreat since 1937.
Google, whose stock slumped 56 percent in 2008, repriced employee stock options this month to restore their value.
“Because motivating and retaining employees is a good thing, both for those employees and our shareholders, we believe this exchange works for all involved,” Google spokeswoman Jane Penner said in an e-mailed statement.
No Permission
Google swapped employees options for the same number of new ones. The company conducted the exchange without shareholders approval and allowed executives in on the plan.
Few will be able to mirror Googles approach, McGurn said. After the repricing frenzy that followed the dot-com bust, the New York Stock Exchange and the Nasdaq Stock Market introduced rules in 2003 forcing most companies to get shareholder approval before enacting programs.
Google has a clause in its 2004 stock plan that exempts it from a shareholder vote. Most companies dont have that kind of exclusion, and even those that do will likely seek investor approval, McGurn said.
“To ignore shareholder value in terms of the dilution would be completely detrimental to future shareholders,” said Daniel Morgan, a fund manager at Atlanta-based Synovus Securities Inc., which owns shares of Apple Inc., Cisco Systems Inc. and Intel Corp. “If they allow the type of things that happened in the past, then shareholders will be screwed.”
Googles Model
To lure and keep employees, companies hand out options that give them the right to buy stock at a set price in the future. The idea is if the company does well, the stock price rises above the strike price of the option. That rewards employees, who can buy shares for less than the market price.
Under Googles repricing plan, employees had the option to buy the stock at $308.57. That compares with the peak market price of $747.24 in November 2007. All company executives could participate — except for co-founders Larry Page and Sergey Brin, and Chief Executive Officer Eric Schmidt, who dont hold options.
The program will cost about $460 million, which will be recorded as stock-based compensation, Google said Jan. 22. Google shares rose 22 cents to $330.16 on March 20 in Nasdaq Stock Market trading.