Australia: Employee Option Plans After The Crash: Are Your Employees Still Motivated To Perform?

Last Updated: 23 December 2008
Article by Shane Bilardi and Andrew Spalding

Following the big fall in the stock market this year, many employees find themselves holding options under employee option plans that are well out-of-the-money. Employee option plans play an important role in retaining and motivating staff and driving long-term business performance. Employers considering ways to reinstate the value of these option plans will need to negotiate their way through their option plan rules, the Corporations Act, the ASX Listing Rules (in the case of listed companies) and the income tax legislation to avoid adverse tax consequences for their employees.

To assess the impact of the crash on employee option plans, Deacons recently undertook a survey to examine the role of options and other share-based plans in executive remuneration and the extent to which options issued under those plans are out-of-the-money. For S&P/ASX 50 companies, we found that:

  • 42% have options on issue under either current or expired employee option plans.
  • While the options issued under those plans since 2003 are on average only 4% out-of-the-money (that is, the share price is an average of 4% below the exercise price), this result is somewhat skewed by strong performances by a couple of companies with 73% of the option tranches issued since 2003 being out-of-the-money.
  • 84% have performance rights plans.
  • Only 2 have employee options plans but do not have a performance rights plan.

However, our findings were quite different when we examined a sample of 50 of the 200 companies from the S&P/ASX Small Ordinaries. We found that:

  • 64% have options on issue under either current or expired employee option plans.
  • The options issued under those plans since 2003 are on average 48% out-of-the-money and 88% of the option tranches issued since 2003 are out-of-the-money.
  • Only 30% have performance rights plans (14% have only performance rights plans and 16% have both employee option plans and performance rights plans).

It appears that the S&P/ASX 50 companies learnt a lesson from the dot-com crash and moved to performance rights schemes rather than employee option schemes to ensure that their incentive schemes continued to motivate their employees during downturns in the market. If our sample of Small Ordinaries companies is representative, it appears that the same cannot be said for many companies outside of the S&P/ASX 100 and this could have an adverse impact on their ability to retain and motivate their key employees. This is particularly the case given that comparatively larger falls in the share prices of the companies in the S&P/ASX Small Ordinaries index have led to their option plans being well out-of-the-money.

A more detailed outline of this survey is available from our website information on the methodology and limitations of the survey.

Options vs Performance Rights

Options granted under employee option plans typically have an exercise price which is at or around the market price of the share at the date of grant of the option. There is then a period after the grant (usually between 2 and 4 years) before the options vest in the employees (that is, before the employees become entitled to exercise the options). Vesting of the options is commonly subject to conditions and/or performance hurdles. Following the vesting of the options, the employee then has a period of time (typically a few years) in which to exercise the options.

In contrast, performance rights have a nil exercise price and are contractual rights to receive shares in the future. As with options, there is a period of time before these rights vest and vesting is dependant on certain conditions and/or performance hurdles being met. Following vesting, there is a period of time (typically a few years) during which the employee can exercise the rights. For the purposes of our analysis, we classified zero exercise price options (ZEPOs) as performance rights as they have a similar economic effect.

Performance hurdles generally involve comparing a company's total shareholder return against a comparator group of similar companies. Accordingly, provided that the company matches or outperforms its peers, these rights can vest even in a falling market.

The important difference between options and performance rights is that vested performance rights still have value to an employee even where the company's share price has dropped well below the share price at the time those rights were granted. For example, if the number of performance rights to be granted to an employee was determined based on a fair value of $20 and the employee was issued 1,000 performance rights (i.e. they have a notional value of $20,000), even if the company's share price has dropped to $10 at the time at which the rights vest the employee will still be entitled to be issued with 1,000 shares with a value of $10,000 after vesting without having to make any payment (as there is no exercise price).

However, if, in the same scenario, the employee had been granted options instead of performance rights with an exercise price of $20, the share price would need to recover to $20.01 before those options had any value to the employee.

Taxation of employee option schemes

Where a taxpayer acquires options under an employee option scheme, Division 13A of Part III of the Income Tax Assessment Act 1936 includes any "discount" (compared to market value) given in relation to the options in the taxpayer's assessable income.

Generally, employee option plans are structured to provide employees with the ability to take advantage of a concession known as the "deferred tax method". Under this concession, the employee may generally defer the taxing time until the option is disposed of or exercised. This contrasts with the ordinary rules that require tax to be paid in the year in which the options are acquired (known as the "up-front tax method").

Dealing with out-of-the-money options

There are a number of different methods that are often considered when dealing with out-of-the-money options. In each case, actions taken need to be consistent with the option plan rules. Where actions that need to be taken are inconsistent with the option plan rules, those rules need to be amended or employees otherwise need to agree to the necessary actions.

Amend to reduce option exercise price to better reflect current share price?

Where the option exercise price is reduced, there are unlikely to be any adverse tax implications for employees.

However, for listed companies, an amendment that has the effect of reducing the exercise price, increasing the period of exercise or increasing the number of shares received on exercise, will constitute a breach of Listing Rule 6.23 which expressly prohibits such amendments, .

Cancel existing options for new options?

The tax implications for employees of the cancellation of options in circumstances where new options are issued are not entirely clear but cancellation may potentially result in double taxation for employees. Further, there is a real risk that ASX could determine that these transactions are, in fact, part of the same transaction having the effect of reducing the exercise price on the options and therefore prohibited under Listing Rule 6.23.

Issue new options without cancellation of existing options?

Where new options are issued without the cancellation of the existing options, there are unlikely to be any adverse tax implications for employees. Employees who have paid tax under the up-front method should be entitled to a refund of tax when their existing options lapse. Employees will then be taxed on their new options under Division 13A applying either the up-front tax method or the deferred tax method.

Although there is still a risk for listed companies of ASX aggregating the two option issues as a single transaction, in our view, the issue of new options without the cancellation of existing options should not breach Listing Rule 6.23.

However, care should be taken to ensure that the new options will not take the company above the 5% limit under ASIC Class Order 03/184. If the 5% limit will be breached, a disclosure document for the new options will need to be prepared and lodged with ASIC unless a specific exemption is sought and obtained from ASIC.

Perhaps, the more significant risk with this approach is that the existing options (currently out-of-the-money) regain their value as the company's share price increases, leading to a double benefit for the employee.

Implement a performance rights plan

While a performance rights plan cannot replace options that will expire in the near future, it may provide a better mechanism for motivating employees in the future. Performance rights plans arguably promote better alignment between the interests of employees and shareholders and operate more effectively in a downturn.

Performance rights plans are taxed in a similar way to employee option plans.

For listed companies, a new performance rights plan will require shareholder approval or all securities issued under the plan will need to be counted toward the 15% cap in Listing Rule 7.1.

Further approval will be required if shares are to be issued to a director under the plan.

What does this mean for you?

Employers considering ways to reinstate the value of their employee option plans should be aware that there are a number of different methods that can be used which have varying implications under the Corporations Act, ASX Listing Rules and income tax legislation. For employers that decide not to do anything, it may be worthwhile to remind employees that have paid tax under the up-front method that they should be entitled to a refund of tax if their options are still out-of-the-money at the end of the exercise window.

It is also worth reviewing whether employee option plans are still the best mechanism for motivating employees and considering whether your company should adopt a performance rights plan.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Shane Bilardi
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.