If you are like most companies, two things have happened since the start of the year:
If you issued any equity awards, annual or otherwise, prior to February 19, when the stock market started its freefall, you may be wondering what can be done about these now underwater awards. For today’s blog entry, I discuss some alternatives.
We typically use the term “underwater” in reference only to stock options, but a decline in stock price can also affect RSUs. For example, assume that an employee award was granted a promised RSU worth $10,000 on February 19, when the market was at a high point for the year. Since then, the stock has lost, say, 60% of its value. That RSU is now worth only $4,000. Even thought the RSU still has some value, the employee probably feels cheated.
For stock options, one alternative is to reduce the exercise price, otherwise known as repricing. The good news is that this can be done on a cost neutral basis by reducing the number of shares in the option, commensurate with the current value of the option.
The bad news is that there are a host of other legal considerations. The accounting treatment is complex, most public companies will need to obtain shareholder approval for the repricing, and the transaction is often subject to the SEC’s tender offer requirements. Moreover, repricing only works for stock options; because RSUs already have a price of $0, they can’t be repriced.
Another alternative is to simply issue additional grants. To make the employee in my earlier example whole, we could simply issue another RSU to make up some, if not all, of the value that was lost. This works for both RSUs and stock options and doesn’t have any complicated accounting and legal consequences to consider. But it could have a big impact on your burn rate and share reserve and, of course, the company will recognize additional expense for the grant.
Another possible solution is to provide a cash payment to employees, either in addition to or in exchange for their equity awards. If awards are to be exchanged for cash, this comes with its own set of legal considerations (compliance with the SEC’s tender offer rules to start with) and there are financial implications for the company (both P&L expense and cash flow).
Finally, it may simply be too early to make any decisions about equity awards. The market has experienced a lot of volatility for the past month and a half—a lot of downs, but some ups as well. As of yesterday, both the S&P 500 and the Russell 3000 had recovered about 20% off their low on March 23. Is this recovery a blip or a trend? It’s hard to say.
There are risks to acting too early. The company’s stock price could recover, making any action taken (and expense incurred) unnecessary. It is important to consider optics—you don’t want it to ook like the company’s misfortune produced a windfall for executives and employees.
There is also the risk that the company’s stock will continue to decline and any action taken will be ineffective, leaving the company in much the same position that it was in before, except possibly with more expense to recognize. Waiting until the markets have stabilized can help mitigate both of these risks.
Stay safe and healthy!
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