Stock Options: Back on the Front Page
Feb 25, 2009
February 25, 2009 - Employee stock options are making headlines again. Last month, Google announced it was resetting more than eight million stock options at lower prices to reflect current market conditions. These options had fallen well below the option prices set years ago and are now considered worthless. (Google shares have dropped 57% since their peak price of $747 in 2007). Fifty-eight companies re-priced options in 2008 and many more are expected to follow suit as they try to make up for losses in this tumultuous market. Needless to say, these resets have irked shareholders still facing losses on their investments.
The Rationale
There is no debate that underwater options create negative morale for employees. Many in favor of option exchanges believe that options for options or options for restricted stock can better align employees with shareholders and improve employee morale. Options have been used as an employee retention tool, but underwater options are often perceived as worthless by employees.
The Reaction
Shareholder advocacy groups like Institutional Shareholder Services (ISS) and the media, from the Wall Street Journal to The Motley Fool, have voiced disapproval of option exchange practices: calling into question the ethics of providing a “do over” for employees while shareholders are stuck with massive investment losses.
We have learned from past experience that companies that undertake option exchanges without shareholder approval will receive a vote “Against” or “Withhold” from the ISS; even if the re-pricing was expressly permitted under an equity plan. In turn, this may negatively impact a company’s Corporate Governance Quotient (CGQ) score – ISS’s corporate governance effectiveness rating tool.
Insurance Implications
It is safe to say that in today’s economic climate underwriters of Directors & Officers Liability Insurance (D&O) are sensitized to market capitalization losses. Options exchanges will only heighten this sensitivity and increase scrutiny. The underwriting process for D&O insurance is a subjective and fluid process. Several factors ranging from strength of financials to robust corporate governance practices are taken into consideration by underwriters. Companies considering an option exchange may find themselves with not only the dollar cost associated with the exchange, but also an increase in their D&O insurance premium as underwriters look to adjust for market capitalization volatility, proxy matters, financials statement adjustments and a poor CGQ scores. Option exchanges should be carefully conveyed to the D&O market and underwriters to maximize the results for a successful renewal.
