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October 10, 2001
When Stock Options Go Underwater
For a Limited Time receive a FREE Compensation Market Analysis Report! Find out how much you should be paying to attract and retain the best applicants and employees, with customized information for your industry, location, and job. Get Your Report Now!
the past three years, nearly 90 percent of U.S. public and private technology companies saw employee stock-option grants go underwater, meaning the option's exercise price went higher than the stock's current trading value.

And with September's stock market plunge, the number of companies with underwater employee stock options may now be at record levels, according to an August survey by iQuantic Buck, a San Francisco-based consulting firm.

Yet, even though many options have no current value because they're underwater, employers aren't about to abandon stock options as a means of compensation.

That's the consensus of more than 200 human-resources and compensation executives from primarily high-tech firms who late last month attended a Silicon Valley conference sponsored by iQuantic Buck, the Wall Street Journal reports.

"Options are still viable, and there's still an expectation among employees that they will be part of their compensation packages," said Laura Brown, Americas/U.S. compensation manager for Intel Corp. in Santa Clara, Calif.

Still, recruited executives negotiating new compensation packages are viewing cash as king. Stock options? They're viewed as an add-on that may be worth something someday, or maybe not, according to search executives on a conference panel.

"They really want the cash," John Haslinger, a principal with Buck Consultants in Boston, told the Journal. "And some want two- and three-year bonus guarantees if they don't feel their options will be worth much."

According to the Journal, stock options remain attractive to companies, particularly start-ups, because they don't have to be charged as an expense to earnings. This makes them effective ways for new companies to conserve cash and still provide employees with competitive pay packages.

Many high-tech companies are retooling option programs to make them more attractive, and companies in other sectors may follow suit. If the economy remains sluggish in coming months, the Journal reports, these trends may emerge:

- Supplemental option grants. About 76% of high-tech firms surveyed in August by iQuantic Buck say they've issued supplemental stock-option grants in the past three years as a way to cope with underwater options, and 69% are considering doing so. The exercise price of the supplemental grants is lower than those of previous grants that now are underwater and may not be "in the money" before they expire.

- Canceled option grants, with new repriced options issued six months later. Companies that simply reprice outstanding options must take a charge to earnings. This charge can be avoided if firms cancel employee options and reissue new grants six months and one day later at the stock's current market price. This so-called six-and-one approach is controversial, since employees are without options for six months.

Staggered grant dates. Instead of issuing stock options to high-performing employees once a year, some companies are granting options in smaller amounts more frequently to help employees cope with market fluctuations.

- Longer vesting periods for stock options and more variable option terms.

Most options vest in four years, but companies increasingly are offering five-year vesting periods, which gives the grants more time to become valuable. Further, while 10-year exercise terms are the norm, companies are offering various other exercise periods, which allow underwater options to expire more quickly and reduces the number of options outstanding as a percent of the total common shares issued --a situation known as "overhang."

To view the Wall Street Journal article, click here.

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