Aligning Stock Option Valuation With The Market

Bill Duratti
February 11, 2009 — 1,924 views  
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As we continue to adapt to the downturn, there are a number of factors around the valuation of companies that are coming into play and, in the end, motivating leaders to re-value options.  We're seeing this trend develop in real time, and it prompted us to put pen to paper for our most recent Perspectives article, "Giving Stock Options A Second Look: The benefits of new grants at low values."

In a nutshell, there is some opportunity that comes with economic free-fall: those companies that provide options are now in a position to get a new valuation and re-energize their workforces with incentives.  That means that even as downsizing and paycuts spread out across the country, management still has the power to provide strong compensation packages.

As we write in the article:

When the profits don't exist to pass on in the way of high compensation, stock options are routinely used to incentivize the employee base and retain key people. With fair values near rock bottom, companies are seizing this opportunity to strategically grant additional options or reprice existing stock options.

However, valuations performed as recently as mid-2008 likely reflect much higher values, so a new valuation may be necessary in order to re-issue and protect the company against negative financial reporting and tax implications. In the long term, the market will most likely rebound and options issued at today's low values will show high yield for fully vested employees. For those not yet vested, the return to value will bring high appeal to staying with and growing the company.

This line of thinking is no fluke; Google is making a lot of noise with its announcement that the company will allow employees to exchange their underwater options - some valued around $160 above the current market price - for newly priced options.  The move brings to the public eye aspects both positive:

Google's willingness to reset more than 8 million stock options at lower prices is likely to spur similar gestures by companies hoping to motivate their employees during a demoralizing recession.

"There is a lot of momentum building" to reprice stock options, said Alexander Cwirko-Godycki, a research manager for executive compensation specialist Equilar. "Everyone has just been sort of waiting for a big name to do it."

and negative:

But Google's repricing program made a bigger splash because it's far more generous to the employees - much to the dismay of the shareholders who have seen their holdings in the Internet search leader plunge by 57 percent, or a collective $130 billion, since the stock peaked at $747 per share in 2007.

For public and VC-backed companies, the value of ownership is most certainly a consideration, and the Board should be well educated on the pros and cons of repricing.  With equity values low and so few alternatives to reward talent, it's a route that should be given serious thought.  We'll be keeping our eyes on this and expect to see more questions and activity on the subject.

Bill Duratti