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The Honolulu Advertiser
Posted on: Sunday, March 15, 2009

Repricing plans rescue worthless stock options

By Tomoeh Murakami Tse
Washington Post

WHAT IS A STOCK OPTION?

It gives the holder the right to buy stock at a future date for a specified price. Stock options can account for a significant portion of pay for some employees, especially executives.

HOW DOES A STOCK OPTION WORK?

When an executive receives stock options, they have a value attached to them, usually the stock's price at the time of the award. The executive may have to wait for a period of time before he or she is vested or can cash them in. When the executive decides to exercise the options, he or she gets the difference between the price of the option when it was awarded, also known as the strike price, and the current price of the stock. For example, 100,000 vested stock options with a "strike price" of $30 would translate to a $2 million profit if the company's stock is trading at $50. If the price of the stock is below the price of the options, the options in practical terms are worthless.

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WASHINGTON — Nearly 100 companies have undertaken programs that allow employees, many of them executives, to exchange sharply depreciated stock options for new awards with more generous terms.

The companies, from Google to United Therapeutics, argue that the exchange — which increases the chances that executives will be able to collect rewards even though the company stock has plummeted — is necessary to retain and motivate personnel.

Critics say the practice undermines the purpose of performance-based bonuses and puts the company's executives and workers on a different plane from ordinary shareholders, who have no choice but to hold on to battered stocks or sell them at a loss.

"It goes to a sense of entitlement, which I think is misplaced," said Con Hitchcock, a lawyer who advises activist investors on corporate governance. "There are a lot of people other than executives who could use good-performing stock in their portfolio."

Stock options can account for a significant portion of pay for some employees, especially executives. They give the holder the right to buy stock at a future date for a specified price. For example, 100,000 vested stock options with a "strike price" of $30 would translate to a $2 million profit if the company's stock is trading at $50. The strike price is typically the price of the stock on the day the options are awarded.

The collapse of the stock market has dimmed prospects for cashing in existing options. Since the beginning of last year, at least 96 companies have implemented or proposed option repricing or exchange programs, according to Equilar, a compensation research firm.

As of late last year, nearly 99 percent of Fortune 500 chief executives held options with strike prices above the current stock price, Equilar said. Such options are "under water."

As a result, Equilar expects 21 companies will implement exchange or repricing programs in the first quarter of 2009, compared with only seven during the same period last year. An additional 24 companies, including Starbucks and chipmaker giant Advanced Micro Systems, have proposed such programs, most of which are subject to shareholder approval.

Many other companies are expected to take similar action, compensation advisers and directors say. As the recession deepens, they say, shareholders should expect a surge in the number of companies repricing options.

Google is in the process of implementing a program that allows holders to exchange their options for new ones with a strike price equal to the closing price Friday of $308.57. It reached a high of $741.79 about 15 months ago.

"It just makes sense given our goal to retain employees," said Google spokeswoman Jane Penner, adding that 85 percent of employees had options that are under water. "We just want to reward people and keep them engaged and focused on serving users. This is a great way to do it."

Google is expected to take a $460 million charge on the options exchange program.

United Therapeutics undertook an options exchange approved by the compensation committee of the board of directors shortly after the company announced that a drug it was developing had produced unfavorable results in a clinical trial.

The company's stock plunged on the Nov. 17 news, although it has recovered some since. A spokesman said last week that the exchange was appropriate given the market environment and the company's continued desire to utilize stock options as a retention tool.

Patrick McGurn, special counsel for proxy adviser RiskMetrics Group, said exchange programs are "never a good thing." But, he added, "If everybody is walking out the door, what are you going to do? Hold back on principle? Or find something that's workable in a shareholder-friendly way?"