Canada: Dealing With Underwater Options: Sinking Or Swimming In The Credit Crunch

Many companies have stock options that are underwater (the exercise price is higher than the current share price). Substantially underwater options are generally a poor incentive because they have no value unless the share price increases dramatically. Having a large "overhang" of underwater options uses up the shares reserved under the option plan, so new options cannot be granted; this prevents a company from implementing new option-based compensation.

There are four approaches to dealing with underwater options.

  1. Ride it out
  2. Cancel options
  3. Reprice options
  4. Reprice and compress options

1. Ride It Out

If options are not significantly underwater, maintaining existing options and providing some other performance incentives (such as a cash performance bonus) can be a workable solution, particularly if the share price is showing signs of recovery.

2. Cancel Options

A company may cancel underwater options so that it has room under the option plan to make new option grants with a fair market value exercise price. However, if replacement options are granted within three months of the cancellation, TSX will treat the cancellation as a repricing requiring shareholder approval. Further, most options require the consent of the optionholder to cancel even underwater options.

3. Reprice Options

A repricing is a reduction in the exercise price. For tax reasons and to comply with TSX rules, the new exercise price cannot be less than the price of a share on the repricing date. Repricings were very common a few years ago, when the tech bubble burst.

Now, most shareholder activists have indicated that they oppose a repricing of options. In particular, in Canada, the public materials from the following organizations state that they will vote against option repricings: Ontario Teachers' Pension Plan, Ontario Municipal Employees Retirement System (OMERS), CPP Investment Board, Canadian Coalition for Good Governance, Public Sector Pension and Investment Board, British Columbia Investment Management Corporation and Ethical Funds.

The general rationale that these groups give for opposing option repricing is that the purpose of an option grant is to create alignment of interest between shareholders and management, and a repricing destroys that alignment by giving management a "fresh start" that shareholders cannot get.

Google repriced its options earlier this year under a rare U.S.-governed option plan that did not require shareholder consent to the repricing. Google's shareholders had no say in the repricing, which made Google take a US$460 million compensation charge.

4. Reprice and Compress Options

Repricing and compressing options involves an exchange of a number of underwater options for fewer options with an exercise price equal to the current share price.

To give a very simple example, assume the current fair market value of a share is $1. Employee A has 10 options with an exercise price of $2 and with a Black-Scholes value of 50¢ per option, and Employee B has 10 options with an exercise price of $5 and a Black-Scholes value of 10¢ per option. Employee A's options would be exchanged for $5 of options with a $1 exercise price (based on of a Black-Scholes valuation), and Employee B's options would be exchanged for $1 of options with a $1 exercise price (based on a Black-Scholes valuation).

Repricing and compressing has the following advantages:

  • It gives key employees options with an exercise price equal to the current share price, which is a more effective incentive than options that are substantially underwater.
  • It reduces the number of outstanding options and the level of potential shareholder dilution.
  • The reduction is effected on a basis that is proportionate to the value of the option and the amount by which each option is underwater. This is fair among optionholders. A simple repricing gives a greater benefit the more underwater the options.

For companies that are not in a position to make cash awards (either cash bonuses or phantom equity awards) because of cash flow issues, repricing and compressing may be better than increasing the number of shares available under the option plan or amending the option plan to allow the grant of whole share compensation (i.e., restricted stock and restricted share units).

Provided that no "in-the-money value" is created on the repricing, and the exercise price of new options is not less than the current value of a share at the date of the repricing, an option repricing and compression can usually be effected without Canadian tax consequences.

RiskMetrics in Canada has indicated that it will generally vote against repricing, but will make exceptions if repricing is part of a broader plan amendment that substantially improves the plan and provided that the following conditions are met: (i) a value-for-value exchange is proposed; (ii) the top five most highly compensated executives are excluded; and (iii) the options that are cancelled on the repricing are not available for re-issuance under the plan.

In the United States, the reaction of shareholders is less categorical and more dependent on the particular circumstances. There, RiskMetrics makes case-by-case decisions that depend on

  • the historic trading patterns of the stock – the stock price should not be likely to be back in-the-money in the near term;
  • the rationale for exchange, particularly that the reasons for the reduction in share price were beyond management's control;
  • whether the exchange is a value-for-value exchange;
  • whether surrendered stock options are added back to the plan reserve;
  • whether the new options have a blackout period and do not vest immediately;
  • whether the term of the replacement option has the same term as the old (replaced) option;
  • whether the exercise price is set at market price or a premium to market price; and
  • whether executive officers and directors are excluded from the exchange.

Earlier this year, approximately 71% of Fortune 500 companies had options that were, on average, underwater. Over 100 U.S. companies have repriced options in the last one and a half years. As companies struggle to motivate management, we expect to see more repricings, despite shareholder opposition.

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.

In association with
Related Topics
Related Articles
Related Video
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions