Avoid Votes on Repricing
Submitted by: Ryan Thomas and Stephen Farr,
U.S. Research Analysts
Option repricing becomes an issue whenever a company experiences a decline in share price, such as that which has occurred at many issuers over the past year, leaving a large number of outstanding option grants with exercise prices higher than current market prices for the underlying shares. Companies argue that these underwater grants cause morale problems and lose their incentive value if employees do not foresee the stock price recovering, especially when the price decline was precipitated by external events perceived to be unrelated to management’s performance. Technology-focused firms, many of which grant options broadly to their employees, tend to argue this point most vocally.
However, a substantial number of issuers do not seek shareholder approval before repricing options. According to a RiskMetrics Group report on the information technology, media, and telecommunications (TMT) sector to be released next week, 19 companies—45 percent of the firms studied—did not ask for investor approval. That group included nine technology firms.
Another 22 companies (with 10 in the technology sector) did put option exchange programs on the ballot in 2008. This year, at least seven firms so far have sought shareholder approval. Repricing proposals are on the ballot at Advanced Micro Devices, Shoretel, Integrated Silicon Solution, SoftBrands, Macusani Yellowcake, and Paramount Gold and Silver; a repricing request went to a vote at Spark Networks on Jan. 5.
The term “repricing” is often used broadly to refer to amending outstanding stock options to lower the exercise price after the date of grant, or to cancel out-of-the-money options and regrant the underlying shares at then-current fair market value, or to replace them with another type of award or exchange them for cash.
New York Stock Exchange-listed companies may not undertake option repricings or exchanges without shareholder approval, unless stockholders have approved an equity plan that explicitly permits such action. The rules for NASDAQ companies are slightly different. The NASDAQ states that if a company’s equity plan is silent on the repricing of outstanding awards, then it is left to the company’s discretion to interpret the plan with regard to this issue.
Of the nine technology companies that did not put their repricing programs to a vote in 2008, five had omnibus stock plans that permit repricing, while three were silent on the issue (two of these are NASDAQ-listed, and one is traded over the counter). The remaining company, Virage Logic, implemented a value-for-value exchange program, although its omnibus plan expressly prohibited option repricing without prior shareholder approval and implied that such approval would be sought for any bailout of underwater options.
In voting on repricing or option-exchange proposals, shareholders typically consider key factors such as:
--The timing of the transaction and which options are eligible for the exchange (evaluating whether companies are pulling the repricing trigger too soon, based on their historical price volatility, and whether firms are including too many new grants that might regain in-the-money status during their terms);
--Whether top executives and directors are eligible to participate in the exchange, which is generally disfavored by investors; and
--Disposition of the shares underlying options that are cancelled. For example, seven of the 10 TMT companies with option-repricing proposals in 2008 permitted the surrendered grants to be added back to the plan reserve and re-issued, a practice known as share “recycling.” Since these shares may ultimately be granted to executives and directors, even if those individuals were excluded from the repricing transaction, this practice is considered problematic by many investors.
There was majority support at all 17 companies where repricing proposals were on the ballot in 2008 (and for which vote results are available). However, there was significant investor dissent at four firms (Toll Brothers, M.D.C. Holdings, Exar, and IXIA) where repricing plans received less than 65 percent support.
Carol Bowie of the Governance Institute contributed to
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