Shearman And Sterling

Capital Markets, Stock Data

March 20, 2020

Revisiting Stock Option Repricing


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Equity-based incentives are intended to motivate high levels of performance and align the interests of employees with those of shareholders. When markets decline steeply, however, many companies find that a significant portion of their employees’ outstanding stock options become “underwater” or “out-of-the-money.”

As COVID-19 continues to cause significant volatility and steep declines, stock options granted in better times are posing particular challenges. Underwater stock options have a number of negative consequences. First, they fail to provide their intended incentive, motivational and retentive benefits. Second, they cause companies to take accounting charges for equity awards that are not providing value to employees or the company. Finally, they are an inefficient use of a company’s equity reserves as they continue to count against a company’s share plan limits, thus limiting the number of new awards that may be granted. Currently, we are seeing a renewal of discussion regarding option repricing, which would revive issues last considered on a large scale during the 2008 financial crisis.

This memorandum discusses the key considerations for companies and their boards as they contemplate repricing options.

How to Handle Underwater Stock Options

One way companies can counteract the negative effects of underwater stock options is to conduct a stock option repricing or option exchange program. Under an option exchange program, underwater stock options are surrendered by employees and replaced with options that have a lower exercise price, typically the fair market value of an underlying share on the date of the exchange. In an option repricing, the option is unilaterally amended by the employer to provide for a lower exercise price.

Companies are typically reluctant to reprice options due to restrictions imposed by the New York Stock Exchange (“NYSE”) and The NASDAQ Stock Market (“NASDAQ”), prohibitions of such programs under existing equity plan terms and the negative perception of these programs by shareholders and the media. Given recent market declines, however, a resurgence of stock option repricing and exchange programs may occur as we saw following the 2008 financial crisis.

When a decline in a company’s stock price is not a result of management’s poor performance, but instead is due to global market declines, an affected company may wish to reset option exercise prices. In assessing whether to proceed with a stock option repricing or exchange offer, boards and management must weigh multiple considerations, such as: whether employees will be rewarded in an outsized manner upon a quick recovery in the stock price, how to motivate and retain employees—who may be exerting herculean efforts in extreme circumstances—and the reaction of shareholders who also may have sustained significant losses.

In many instances, a stock option exchange program benefits both a company and its shareholders. Cash-poor companies that rely on equity awards as a means to provide long-term incentive compensation may be depleting existing share reserves under their equity compensation plans on options with little chance of coming into the money during their terms. Underwater stock options may cause a company to incur accounting expenses for a compensation award that provides little retentive or incentive value. As a result, a company may be forced instead to use cash to provide incentives. By permitting a stock option exchange, shareholders can reduce overhang, thereby increasing the available share pool under a company’s equity plans and stem undesirable accounting consequences. The following is a summary of various forms of stock option exchange programs and the associated issues that companies should consider in determining whether such a program is appropriate.

Forms of Stock Option Exchange Programs

For purposes of this memorandum, the term “stock option exchange” program broadly refers to a number of practices summarized below. The primary difference among these programs is the form of consideration given by a company in return for an employee’s participation.

Stock Option-for-Stock Option Exchange Programs. In a stock option-for-stock option exchange program, underwater stock options are cancelled and replaced with new stock options that have an exercise price that is equal to or greater than the market price at the time of the new grant. The company determines the applicable exchange ratio for the program (which is often less than one-for-one, providing employees with fewer new stock options for each option exchanged). Companies frequently use a value-for-value exchange ratio whereby the value of new stock options equals the value of the cancelled stock options, using a common option valuation method, such as Black-Scholes or binomial lattice. The terms of the new stock options can differ from the terms of the cancelled stock options. Employers commonly modify the term of the new stock options and subject the new stock options to additional vesting and forfeiture conditions.

Stock Option-for-Other Security Exchange Programs. In a stock option-for-other security exchange program, underwater stock options are exchanged for a different type of equity-based award, such as restricted stock, restricted stock units or phantom stock. The amount of the new equity award is generally determined on a value-for-value exchange basis, but this is not required. The new equity awards typically have additional vesting and forfeiture conditions.

Cash Exchange Programs—“Stock Option Buyouts.” In a cash exchange program, which is sometimes referred to as a “stock option buyout,” underwater stock options are purchased by the company for cash. The cash payment amount is typically determined pursuant to a stock option valuation methodology, such as Black-Scholes or binomial lattice. The cash payment to employees may be made immediately, or over time, and may be subject to future vesting or forfeiture conditions.

Stock Option Repricing Programs. In a pure stock option repricing program, the exercise price of underwater stock options is unilaterally reduced by the company by amending the option award without any exchange of rights.

Choosing an Approach

Decisions regarding the type of stock option exchange program to implement are fact specific. The table below compares some of the advantages and disadvantages of each of these programs.


Option-for-Option Exchange

Option-for-Equity Exchange

Cash Exchange

Option Repricing


Relatively easy to explain to employees


Preserves shares available for future issuances (depending upon share counting provisions of plan)


Protects employees against further stock price declines



Reduces share overhang (where no new shares issued and exchange ratio is less than one-for-one)


Stock option holder consent not required





Negatively perceived by the market

Requires shareholder approval


Requires a public tender offer


Requires consent of option holders to agree to participate


Stock options may become underwater again



Employees lose the opportunity to benefit from future stock price appreciation




Employees have less control over the timing of the taxable event



Requires a cash outlay by the company




Shares are not added back to the plan





Shareholder Approval

Both the NYSE and NASDAQ require shareholder approval prior to commencing a stock option exchange program (other than a stock option buyout for cash), unless a company’s equity plans specifically permit repricings or exchange offers.[1] In addition, as discussed below, many institutional investors and proxy advisory firms, including Institutional Shareholder Services (“ISS”), provide guidelines regarding considerations to be taken into account in determining whether to approve, or recommend for approval, a stock option exchange program.

In deciding which stock options are eligible for exchange, companies should keep in mind that institutional shareholders often are reluctant to approve exchange offers involving recently-granted stock options and are more likely to approve programs that are limited to stock options that are significantly underwater. Offering to exchange options that are only slightly underwater, or permitting directors and senior officers to participate in the exchange, may cause investors and employees to think that company leadership has little faith in the recovery of the stock price over the long term. To garner institutional shareholder support for a stock option exchange program, investors may compel companies to place limitations on future equity grants, such as: (1) setting a maximum number of shares that may be awarded annually; (2) placing a limit on the maximum number of shares that may be awarded to an individual; (3) establishing minimum vesting requirements; and (4) providing a maximum term during which an equity award may be outstanding. 

ISS’s Position on Stock Option Exchange Programs

Option Exchange Proposals. ISS recommends “for” option exchange programs on a case-by-case basis. Its voting guidelines list a number of factors that will be taken into consideration, including whether the stock price decline was beyond management’s control. In addition, to receive ISS support, executive officers and directors must be excluded from the program and the exchange must occur at least one year out from a precipitous drop in the company’s stock price (with the exercise price of the surrendered options being above the 52-week high). Companies seeking approval for an option exchange should also take care in crafting the shareholder proposal, which should clearly articulate why the board is choosing to conduct an exchange program.

Conducting a repricing (which ISS defines to include a cash buyout or a voluntary surrender of underwater options where the shares surrendered may subsequently be re-granted) without prior shareholder approval could lead to an ISS recommendation against members of the compensation committee, and possibly the full board, even if the exchange is permitted under the existing terms of the company’s equity plan. In addition, because ISS considers repricing without shareholder approval a “problematic pay practice,” companies should expect a negative say-on-pay recommendation. It is important to note that the universe of programs for which ISS requires shareholder approval is greater than the universe required by the NYSE and NASDAQ. Therefore, a company that structures its exchange program as a cash buyout of underwater options should still plan on seeking shareholder approval, even though not required by the applicable exchange.

Due to these ISS guidelines and the expectations of institutional investors, directors and executive officers are frequently excluded from participating in option exchange programs. Nevertheless, because those individuals typically hold a large number of options, excluding them can undermine the goals of the program and can exacerbate executive retention and motivation concerns. As an alternative to excluding them outright, companies could consider having directors and executive officers participate in a similar program on less favorable terms than other employees, and could also consider seeking separate shareholder approval for that offering to avoid jeopardizing the overall program.

Equity Plan Proposals. ISS evaluates equity plans under its “Equity Plan Scorecard,” which takes into account a number of factors that ultimately lead to a plan “score” of up to 100 possible points (with 55 or more points resulting in a positive recommendation). As provided in its related FAQs, a plan provision that permits repricing without shareholder approval—either by expressly permitting it or by not prohibiting it when the company has a history of repricing, by permitting cash buyouts of options, or even surrendering underwater options and making the underlying shares available for regrant—will constitute an “overriding factor” that may lead to an “against” recommendation on an equity plan proposal, regardless of the plan’s scorecard score.

Other Business and Legal Considerations

U.S. Accounting Treatment. Companies should consult with their auditors before proposing an option exchange. Under Accounting Standard Certification Topic 718, an option exchange is considered a modification of the outstanding options participating in the exchange and incremental compensation expense will have to be recognized to the extent that the fair value of the replacement awards exceeds the fair value of the cancelled options.

U.S. Tender Offer Rules. Because employees must make an investment decision when electing to participate in an option exchange program, but not a unilateral repricing, exchange programs are generally considered “tender offers” for purposes of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are subject to all requirements of Rule 13e-4 of the Exchange Act. The Securities and Exchange Commission (“SEC”), however, has issued an exemptive order granting limited relief from certain tender offer requirements, including the “all holders”[2] and “best price”[3] rules under the Exchange Act for stock option exchange offers that are effected for compensatory purposes. The exemptive order permits a company to exclude certain employees and tranches of outstanding stock options from the program and enables a company to provide different considerations for different grants. For example, a company may offer different exchange ratios based upon the exercise price or the remaining term of the underwater stock options being exchanged.

In order to qualify for relief under the exemptive order, the following conditions must be satisfied: (1) the company must be eligible to use a registration statement on Form S-8; (2) the stock options subject to the exchange offer and the securities offered in the exchange offer must be issued under an employee benefit plan[4]; (3) the program must be conducted for compensatory purposes; (4) the company must disclose the essential features and significance of the exchange offer, including risks that option holders should consider in deciding whether to accept the offer; and (5) except as set forth in the exemptive order, the company must comply with the tender offer rules of Rule 13e-4.

Pursuant to Rule 13e-4, upon commencement of a stock option exchange program, a company is required to file a Schedule TO with the SEC and leave the offer open for at least 20 business days. A central component of the Schedule TO is an “offer to exchange” document that outlines the terms of the stock option exchange program. The offer to exchange must be distributed to all eligible employees either electronically or by mail. Generally, a company must file with the SEC all written communications made prior to, or following, the commencement of the tender offer, including any press releases and employee communications (whether written or oral). Filing of these communications must be made on a Schedule TO-C “as soon as practicable on the date of the communication.”

Once a tender offer has commenced, it is subject to SEC review and comment. Given the compensatory nature of stock option exchange offers, in most instances the SEC will be satisfied with additional supplemental information (which is provided only to the SEC) supporting the original disclosure or clarifying amendments to the Schedule TO. If, however, a major disclosure issue arises with the SEC, a company may be directed by the SEC to send participants in the offer a supplement to the offer in order to clarify or supplement the original disclosure.

U.S. Securities Laws Disclosure. If shareholder approval is required to implement a stock option exchange program, a company must disclose the material terms of the exchange in the proxy statement in which approval is sought. If a company’s need for shareholder approval does not coincide with the timing of its annual shareholder meeting, a special shareholder meeting will be necessary to obtain the necessary approval. Disclosure also will be required in the “Compensation Discussion and Analysis” of the company’s next proxy statement, but only to the extent named executive officers participated in the program. In addition, if named executive officers or directors participate, the incremental value of the modified award must be reported in the summary compensation table and any new equity awards granted must be disclosed in the “Grants of Plan-Based Awards” and “Director Compensation” tables, as applicable. Stock option exchanges and repricings also will trigger the need for any participating directors and executive officers to file a Form 4 with the SEC, both with respect to cancelled stock options and new equity grants.

Share Registration. Before launching an option exchange program, companies should determine whether they have share capacity on an already filed registration statement on Form S-8. If additional shares are needed, an amended registration statement will need to be filed.

U.S. Tax Treatment—Incentive Stock Options. If the options subject to the exchange are incentive stock options (“ISOs”), an option exchange will constitute the cancellation of the ISO and the concurrent grant of a new stock option (which needs to be separately evaluated as to whether it meets the ISO rules). As a result, to the extent the new option is to be considered an ISO, the mandatory ISO holding periods will restart. When determining whether the newly granted options qualify as ISOs, keep in mind that when ISOs are cancelled in an exchange, the cancelled ISOs that were exercisable within a year of the cancellation will count towards the $100,000 limit on the number of ISOs that may become exercisable in a calendar year for any participant. Finally, if an option exchange offer remains open for more than 30 days, any outstanding ISOs offered to participate in the exchange will be considered modified (and therefore newly granted) on the date the offer was made, which will lead to disqualification of ISOs held by employees who choose not to participate in the exchange.

U.S. Tax Treatment—Section 409A. The cancellation or repricing of stock options is generally treated as a nontaxable exchange under U.S. federal income tax laws. Under the U.S. Internal Revenue Code of 1986, as amended (the “Code”), employees are not required to recognize income for federal income tax purposes upon the cancellation of stock options or the grant of new stock options, restricted stock, restricted stock units or other equity awards that are subject to future vesting. Cash payments made in exchange for stock options are immediately taxable, unless the cash is subject to vesting or other forfeiture conditions.

Section 409A of the Code (“Section 409A”) regulates the tax treatment of nonqualified deferred compensation and restricts the ability of employers and employees to elect when income can be recognized and taxed. Stock options generally do not constitute deferred compensation for purposes of Section 409A, provided that certain conditions are satisfied and the stock options are not “modified” following the grant date.[5] Section 409A defines a “modification” as any change in the terms of a stock option that may provide the stock option holder with a direct or indirect reduction in the exercise price of the stock option, regardless of whether the stock option holder benefits from the change in terms. A stock option repricing or a stock option-for-stock option exchange will result in a modification of a stock option, and will need to have a new exercise price that is at or above the fair market value of the stock to continue to be exempt from Section 409A. Multiple repricings of the same stock option may be problematic, because this may indicate that the exercise price is in fact adjustable, which is prohibited for Section 409A-exempt options. The cancellation of a stock option or the exchange of a stock option for an alternative equity security will generally not raise Section 409A implications; however, the new equity award may be subject to Section 409A.

U.S. Tax Treatment—Section 162(m). Section 162(m) of the Code (“Section 162(m)”) disallows a deduction by any “publicly held corporation” for “applicable employee remuneration” paid to any “covered employee” in excess of $1 million in a tax year. The Tax Cuts and Jobs Act amended Section 162(m) to, among other things, (1) remove the “qualified performance based compensation” exception to the deduction limitation and (2) expand the definition of “covered employee” to include any employee serving or acting as the corporation’s CFO during the tax year and all individuals who were covered employees of the corporation (or any predecessor) for any tax year that begins on or after January 1, 2017.

These changes apply to tax years beginning after December 31, 2017. However, compensation paid under a written binding contract that was in effect on November 2, 2017 may be considered “grandfathered” if it qualified for the performance-based compensation exception and is therefore deductible, so long as it was not modified in any material respect. An option exchange or repricing would constitute a material modification to the original option and eliminate their grandfathered status.

International Considerations

Companies with employees outside of the United States must ensure that any stock option exchange program is conducted in compliance with applicable laws. This requires a review of applicable securities, tax, employment and exchange control laws for each impacted jurisdiction. Companies may need to vary the terms of the offer for participants in non-U.S. jurisdictions to endure compliance. In certain jurisdictions, an exchange will result in an immediate taxable event to an employee participant.

Our Take

Stock option exchange programs can be an effective strategy to counteract motivational and retentive concerns that may arise from underwater options. Nonetheless, the creation, implementation and administration of these programs introduces a myriad of legal, regulatory, tax and employee and shareholder relations issues that companies must consider. Boards and management teams should consult with their legal, tax and accounting advisors before embarking on an option exchange, in any form.


[1]  Shareholder approval is not required for foreign private issuers listed in the United States that undertake stock option exchange programs in compliance with the corporate governance requirements of their home country, provided that they disclose the differences between United States practices and their home country practices in their Form 20-F.

[2]  The “all holders” rule requires companies to make the same offer to all shareholders of a given class of securities. The Exemptive Order allows issuers to exclude specific groups of option holders (e.g., officers, directors, certain foreign option holders and former employees) and certain stock option grants (e.g., stock options below a specified exercise price, unvested stock options and stock options granted under a particular plan or on a particular date).

[3]  The “best price” rule requires that all participants in the tender offer be provided the same consideration for their securities. The Exemptive Order provides relief from the requirement that all option holders be provided with the highest consideration. This permits the company to provide different exchange ratios or cash payment amounts with respect to different stock option grants based upon factors such as the original exercise price, remaining stock option term and/or vesting schedule.

[4]  Under Rule 405 of the Securities Act of 1933, as amended, “employee benefit plan” means “any written purchase, savings, option, bonus, appreciation, profit sharing, thrift, incentive, pension or similar plan or written compensation contract solely for employees, directors, general partners, trustees (where the registrant is a business trust), officers, or consultants or advisors.” Consultants and advisors may participate in an employee benefit plan only if: (i) they are natural persons; (ii) they provide bona fide services to the registrant; and (iii) the services are not in connection with the offer or sale of securities in a capital-raising transaction, and do not directly or indirectly promote or maintain a market for the registrant’s securities.

[5]  Under Section 409A, a stock option does not provide for a deferral of compensation if (i) the exercise price is not less than the fair market value of the underlying stock on the date the stock option is granted and the number of shares subject to the stock option is fixed on the grant date; (ii) the transfer or exercise of the stock option is subject to taxation under Section 83 of the Code; and (iii) the stock option does not include any features for deferral of compensation, other than the deferral of recognition of income until the later of (x) the exercise or disposition of the stock option or (y) the time the stock acquired, pursuant to the exercise of the stock option, becomes substantially vested.

Authors and Contributors

John J. Cannon III


Compensation, Governance & ERISA

+1 212 848 8159

+1 212 848 8159

New York

Doreen E. Lilienfeld


Compensation, Governance & ERISA

+1 212 848 7171

+1 212 848 7171

+1 650 838 3804

+1 650 838 3804

New York

Gillian Emmett Moldowan


Compensation, Governance & ERISA

+1 212 848 5356

+1 212 848 5356

New York

Matthew Behrens


Compensation, Governance & ERISA

+1 212 848 7045

+1 212 848 7045

New York