Hoping shares rise to the surface again

Despite declining markets, stock options may still be an integral part of many companies' reward programmes, writes RENEE JONES

EMPLOYEES IN receipt of share options are, in many cases, casting a rueful eye at this element of their remuneration. The recession and, more importantly, the stock market crash means many of these options are “underwater”.

Niamh Coyne, a partner with AL Goodbody’s corporate department, explains that stock options go “underwater” when the stock option price – the price at which it can be exercised by the employee – is higher than the market value of the shares.

As of this week, the Irish Stock Exchange is trading over 75 per cent below the peak it hit in February 2007.

However, Coyne believes stock options will continue to be a integral part of many companies’ reward programmes, despite the economic downturn.

“Where you might think the current market would be a case for the fall of them, I do not think that it will. I think it will remain relevant and the recession is not going to do away with it. I think it will be cyclical and they will continue to perform as part of employees’ packages.”

That is of little comfort to holders of options in the current market. “If you look at the statistics on the stock market, it is frightening. Most stock options of Irish listed companies are underwater. There is a massive amount,” she said.

“It is difficult to say, but given the economic situation I would guess there would be a lot of private companies that would be underwater.”

Ms Coyne said 60 per cent of companies listed on the Irish Stock Exchange use stock options and most have a combination of schemes directed separately at senior executives and at the wider staff. Share options were widely used as a tool for recruiting and retaining employees during the dotcom boom of the 1990s, a time when many of the fastest growing companies were cash-poor.

“After the dotcom bust, share options declined in popularity as people were left with underwater options or lower pay because the shares were part of a pay package. There was a lot of comment there would be a decline in stock options. There was a lull in popularity, but they came back, and most companies have been granting share options over the last five to 10 years.”

Ironically, Ms Coyne said the recession could positively impact stock options with share prices offering long-term value for staff.

“Share prices are low at the moment, which means that options can be granted with a low strike price, thereby resulting in future value for employees, provided the company comes through these challenging times,” she added.

But what about the underwater options already held by company employees?

Ms Coyne notes that there is a limited range of choices available for companies to deal with underwater options. Companies can choose to do nothing and wait for a market upturn. However, that could impact adversely on the chances of retaining key employees, one key driver of granting options in the first place.

If the granting of options is an annual event, the company can, within limits, adjust the levels of options in the next grant to compensate for underwater options.

Companies like Google have tried to tackle the problem by offering exchange or re-pricing options. But rules introduced in 2000 mean that companies have to include the cost of any repricing in their profit and loss account, making such an option less attractive.

In Google’s case, the move cost the company an estimated $460 million when employees were allowed to swap options with a higher exercise price for new options with a lower exercise price. Starbucks and eBay have also said that they would allow employees to exchange underwater options.

In the case of Irish listed companies, stock exchange rules also mean that repricing could prove difficult.

In addition, the Irish Association of Investment Managers (IAIM) has publicly stated that it is against both the re-pricing and exchange of options. A separate option is the cancellation of existing options and their replacement with new options at revised prices.

“Cancellation and exchange of options is possible without violating the listing rules, but the IAIM and shareholders must be on side to do this,” Ms Coyne said.

“The IAIM have said that for new option schemes and share plans – each company will be examined on a case-by-case basis.”

Private listed companies have greater flexibility with share options because they are less regulated than listed companies.

Ultimately, Ms Coyne argues, there are many benefits for companies to use stock options, including creating upside from current low share prices, aligning the interests of shareholders and employees and assisting cash-poor companies with their remuneration strategies.

They are also low risk for employees as they can choose whether or not to exercise them and Revenue-approved share plans provide important tax breaks for both employees and their employer.