Posted: July 6, 2020
In light of the COVID-19 pandemic and subsequent economic slowdown, many corporations face unique and complex issues in addressing outstanding equity awards. For a large majority of companies, the pandemic has resulted in significant disruption to company operations, leading some firms to file for bankruptcy. In addition, 2020 financial forecasts have been completely upended for most companies, which now find themselves falling short of year end performance targets. Given the uncertainty of when this crisis will end (and the forecasting difficulties it brings), combined with the need for companies to retain and incentivize employees, most companies are reevaluating total reward strategies. Although most proxy advisory firms are not expecting changes to outstanding awards, any adjustments should include clear disclosure on the rationale for doing so. In addition, the decision to change outstanding equity awards should take into consideration any lost value of current equity awards, the type of equity vehicles, share usage and dilution, as well as shareholder and other corporate governance concerns.
With outstanding stock options significantly underwater in the current economic environment, companies have a few choices to counteract the negative effects of underwater stock options: Additional Equity Compensation Rather than adjusting or replacing underwater options, a company can elect to grant additional equity compensation. While this strategy may provide short-term retentive value and allow outstanding awards to remain intact, shareholders may view this approach negatively, since it could result in a windfall to employees (should stock prices rebound to pre-COVID-19 levels). In addition, companies will need to assess whether their equity plans have sufficient share capacity to accommodate any additional awards. Option Repricing With option repricing, the existing award is amended to provide for a lower exercise price - the exercise price of the existing award is reduced to a price at or above the stock price on the date of repricing. However, due to restrictions imposed by the NYSE and NASDAQ, along with the negative perception of shareholders, companies are typically reluctant to reprice options. Option Exchanges Under an option exchange, the existing award is cancelled and exchanged for a new equity award (e.g., option, restricted stock, RSUs, etc.), or cash.
Option repricing or exchanges are often more complex than additional grants, but can be effective in addressing retention concerns. However, for most companies, repricings or exchanges require shareholder approval, and are also subject to heightened scrutiny by institutional investors and proxy advisory firms. In addressing underwater stock options, companies should consider:
In light of current economic challenges, stock price volatility and business uncertainty surrounding COVID-19, performance goals and corresponding targets established in early 2020 or prior will likely not be achieved for many companies. Accordingly, companies may wish to consider modifying performance plans and subsequent awards to enhance retention, and ensure goals are challenging, yet achievable in the current economic environment. Companies considering such actions should be cognizant of:
Using full value awards (e.g., restricted stock) could help offset some of the negative impact of underwater options, as full-value awards maintain at least some value, even in an economic downturn. However, with suppressed stock prices in today’s environment, companies may wish to use supplemental grants to offset some of the lost value. Moving forward, companies may rely more heavily on full-value awards for retention purposes rather than stock options, at least in the near term.
Instead of modifying outstanding performance awards, companies may wish to consider supplemental grants to offset any lost value in outstanding awards. This approach could be an ideal option for companies, as shareholder approval is not required. However, companies must have sufficient share capacity to accommodate any supplemental grants. When considering this option, companies should take into account the following:
Given the market volatility associated with the COVID-19 crisis, companies should consider all available strategies for addressing outstanding equity programs. An option repricing or exchange program may make sense for some companies, if the decline in stock price is solely due to market conditions, and not a result of management’s performance. However, companies should be mindful of the unintended windfall for awards, should stock prices rebound, and conversely (in the case of repricing), if the stock price continues to decline. Alternatively, supplemental grants may be better suited for other organizations, provided there is sufficient share capacity, and the ability to absorb the additional accounting expense. In any event, companies will want to consider utilizing all available tools and resources in addressing outstanding equity programs, while also taking into account the optics of shareholders and proxy advisory firms.