Return to NASPP Blog
The NASPP Blog

Underwater Stock Options: Is a Stock Price Forfeiture Provision the Answer?

Subscribe to the NASPP Blog

January 16, 2020 | Jennifer Namazi

Underwater Stock Options: Is a Stock Price Forfeiture Provision the Answer?

Stock options have long been a part of the equity mix. While the slice of the stock grant pie that represents stock options has scaled back in recent years, giving way to the rise of awards and units, stock options still have a valued place in employee compensation.

Many of us know that one of the most significant challenges arising with stock options is the potential for them to go “underwater” - a scenario where the strike price of the option is higher than the market value of the company’s stock – resulting in no value for the employee. Whereas awards typically always have some value – because they are “full value” when granted (granted with a zero or nominal purchase price) - the strike price attached to stock options makes them more vulnerable to downward fluctuations in stock price when it comes to an actual and perceived value perspective.

Drag on Plan Reserves

I’ve personally held substantially underwater stock options, and I can attest that being in possession of stock benefits that were essentially worthless didn’t help maintain morale or retain talent. This is especially challenging when the conditions that drive the underwater value are more company or industry specific rather than the reflective of the status of the entire market.  One of the most frustrating aspects of having employees who are holding stock options with a value that has slipped below the strike price is that the stock options remain outstanding. They still reduce/affect the company’s available plan reserves, even though they don’t have any current worth and may never be exercised. I’m not necessarily referring to short term market fluctuations that may land an option underwater in the short term. I’m most focused on significantly underwater options that have little chance of coming “into the money.” With option terms that can extend for 7 or 10 years, this is a long time to have such a drag on plan reserves.

Existing Solutions

There haven’t been many great solutions to address the conundrum of underwater options. Repricing the option (modifying the option such that the strike price is dropped to match the underlying stock’s current value) usually requires stockholder approval under both NYSE and NASDAQ listing rules. In addition, in some scenarios a repricing can trigger tender offer requirements under SEC regulations.  There are also potential accounting implications in a repricing, and, in the case of ISOs, tax implications (when an option is cancelled, the holding period for ISOs is cancelled also). Both repricings and tender offers are fraught with compliance triggers and the need to undertake time consuming and costly steps to comply.  Is there no other mechanism to address the lasting impact of underwater options?

Could a Stock Price Forfeiture Provision be the Answer?

In an article on the subject, “Tip of the Week: Could a Stock-Price Forfeiture Provision Eliminate the Existence of Underwater Stock Options,” author Anthony J. Eppert (Hunton Andrews Kurth) presents a potential solution: incorporating a stock price forfeiture provision into the grant agreement that would allow for automatic forfeiture of substantially underwater options in certain stock price situations. Eppert describes this alternative as follows:

"The concept of a stock-price forfeiture provision is simple.  The form stock option award agreement would contain a provision that requires the stock option and the underlying shares to become immediately and automatically forfeited if the price of the underlying stock ever falls to $x.00 (or falls by $y.00, determined as an average over a 6-month period or some other period).  Possible benefits of a stock-price forfeiture provision include:
  • The underwater stock options are no longer outstanding.
  • The forfeited shares should revert to, and replenish, the share reserve of the issuer’s equity incentive plan.
  • The life expectancy of the equity incentive plan’s share reserve is longer when compared to the issuer retaining the underwater stock options as outstanding awards.  [Cross Note: See “Use Inducement Grant to Protect an Equity Plan’s Share Reserve”]
  • Complying with the SEC’s tender offer rules are avoided, as is the time, expense and some of the stockholder relationship issues relating to the same."

The avenue of implementing a stock price forfeiture provision does have a risk to consider, reminds Eppert. Issuing companies should be reminded not to replace a forfeited option with an identical replacement grant. Doing so would be considered a repricing under NYSE and NASDAQ listing rules. A seemingly better approach would be to make a new grant pursuant to the company’s annual grant policy – one that has no relationship to the forfeited option. Would this work to avoid the repricing trap of being a “replacement option”? On paper this solution seems like a good one. However, there isn’t much precedent for it – so legal counsel should definitely be consulted in contemplating such a provision. It’s definitely something to consider in addressing the long standing issue of how to rectify a scenario where stock options fall hopelessly underwater.


About Us

The National Association of Stock Plan Professionals is the largest and oldest professional association for the stock and executive compensation community, with over two decades of leadership providing expert resources, education and other benefits for our more than 6,000 members across 32 affiliated chapters.


P.O. Box 21639 Concord, CA 94521-0639 Telephone: (925) 685-9271 Fax: (925) 930-9284

©NASPP 2019, All Rights Reserved.