|BUSINESSWORLD dated October
your employer hoping the underwater stock options problem will just
go away? He's not the only one it seems
What goes up must come down. Stand this cliche on its head, and
what do you get? The standard policy most Indian corporates are
adopting to deal with underwater stock options. They... hey, hang
on a minute! What are underwater options? Okay, let's tarry a bit
and deal with the jargon first. Underwater Esops are options with
an exercise price much higher than the share price. Net result:
they are worth their weight in, well, paper. Exercising them is
not a good idea unless you want to bankroll your company's latest
If you got any stock options in the last couple of years, they are
likely to be underwater by now. Employees in tech companies have
been the worst hit: the Computer Software Large ASA Index is off
almost 75% since the beginning of last year. Now, we don't know
about your employer, but most companies seem to be going by the
assumption that what goes down must come up. And if the options
are going to resurface on their own sooner or later, why bother
with a salvage operation? According to a survey conducted in April
by Pune-based ESOP Direct -- a company which designs Esop plans
-- over 90% of the companies did not want to change the conditions
of their schemes. It sure helps that the general economic outlook
is depressing. Employees are likely to be more worried about hanging
on to their job than about rescuing battered stock options.
There is also the issue of shareholder-employee conflict. There
are quite a few ways of burnishing Esops (see 'The Employers' Options'),
but most of them involve a trade-off between the rights of existing
shareholders and those of employees looking for a chance to encash
their options. Repricing of options can be especially tricky. If
the repriced options are given at a discount to current market price,
shareholders would be justifiably peeved. Nobody's protecting their
downside, after all. "It is against the shareholders' interest
to frequently reprice the options. It is also against the shareholders'
interest to let options remain underwater for a very long while
and lose the alignment between shareholder interests and employee
interests. Managements will have to strike a fine balance between
dilution and incentivisation," says T.R. Santhanakrishnan,
CFO, Satyam Infoway, India's first ISP to list abroad. Any repricing
could also send a signal that the company is losing faith in its
ability to create value. In that case, the market might just decide
to punish the stock further.
for most firms, it is perhaps as much the lack of pressure from
employees as concern for shareholders that is keeping them from
tinkering with Esop schemes. We decided to run this by Santhanakrishnan.
"There was no pressure to change the terms of the option programmer,"
he says. "Despite the pressure on the option value, Sify has
been able to retain its employees reasonably well."
the bull rampage of 1999 and early 2000, when Esops were
liberally issued by companies, it's time to take stock of
the wreckage. And it's not a pretty sight. Indian employees
have seen the value of their Esops erode faster than you
can say 'tough luck'. The trouble is,employers are clueless
about how to respond.
they must, though. Many Esop schemes were designed to reward
past and future performance.If share prices fall purely
because of market conditions, underwater Esops act like
an involuntary pay cut.
companies have started thinking about alternatives. For
instance, one of our clients is considering cancelling the
old options and designing a new scheme. Another client has
already made a larger grant at current prices, so that employees
can average out their cost. An unlisted company, which had
to defer its IPO, has provided a facility to enable trading
in its shares amongst the employees,so that those in need
of cash can exit.
Here are some of the ways your employer can address this
without cancellation: The exercise price of the
underwater options is changed to a new exercise price that
is equal to the current market price or is at a discount
to the current market price, after getting shareholder approval.
Surprisingly, Sebi guidelines do not mention the accounting
impact of repricing.
and reissue at market price: Another method is
to cancel all the existing options and grant an equal or
fewer number of options at lower exercise price. The company
can reverse the accounting entry for the amount, equivalent
to the discount given at the time of the first grant. If
the new grant is made at the market price, there is no adverse
accounting impact .Shareholders also may not mind this as
options are granted at market price and there is no additional
larger number at current prices: Granting of additional
options at a high discount that would result in averaging
the cost to the employees. A small increase in the market
price would make all the options in-the-money. The accounting
impact of the new grant will be very significant.
alternative is likely to be accepted only in unusual circumstances.
Repricing: Instead of complete re-pricing, companies
can re-price only those options granted to middle and junior
level employees. The logic here is that part of the blame
for the fall in the prices has to be shared by the senior
team and that they should strive to increase the market
valuation. As senior management usually gets the bulk of
the options, the shareholder may not object to such a re-pricing.
Of course, there is no standard solution to the problem
as firms will have different priorities when it comes to
factors like accounting impact and shareholder reaction.
Raymond Arogyaswamy, vice-president
of Polaris, agrees that there is "no problem in the short-term.
I don't think Esops are an attraction or retention factor anymore.
They are a hygiene factor. They have not helped us retain or attract
people." His own options, granted under the Esop 2000 scheme,
are underwater. What does he think about that?
course, I would have been much happier if the share price had
Rs. 3000. But I am not thinking about that at all. In any case,
the exercise period is five years." Not all employees will
take such a long-term view. And any company which doles out Esops
as a reward for past performance, or to retain talent, knows that
it can't afford to short-change employees.
key employees. That could be why, when Polaris came out with a
new scheme -- Esop 2001 -- in April, the grant was given to 300
employees at current market price.
A few other companies are also getting worried. "In the last
six or seven months I have seen some desire to relook at the Esops,"
says K. Pandiarajan, managing director of HR services provider
Ma Foi. In fact, Ma Foi is one of the companies that is actually
doing something about its underwater Esops.It granted more options
to employees at a 20% discount to book value in July. "We
always wanted a broad-based Esop scheme: 38% employees have Esops
now.And if a person leaves, he can actually surrender the shares
at the price bought," says Pandiarajan. Ma Foi is an unlisted
company -- like most dotcoms in India. Didn't Pandiarajan face
any opposition from the VCs (venture capitalists are known to
vehemently oppose any change in Esop terms that could affect the
earnings per share)? "We did face some opposition from our
VCs initially, though they came around when they realized how
important the change was for retention," says Pandiarajan.
Even some MNC employers are working out ways to boost the value
of their options. Buybacks announced by companies like Cisco could
shore up share prices abroad and make the options granted to Indian
employers more attractive.
Whether a company has to change the terms of its scheme finally
depends on just how well designed it is. A multi-year plan where
at-the-money (market price equals exercise price) options are
granted in tranches does not usually need fixing. There is also
an incentive for employees to perform, since a stock price increase
today increases the value of future options as well. So there
you have it. While we are unlikely to see the kind of repricing
that NIIT went in for last April -- the company had lowered the
exercise price of its options from Rs 2,476 to Rs 1,593 less than
three months after shareholders approved its Esop plan -- there
could be some more recovery operations in the offing. Particularly
in cases where top-drawer talent was attracted by dangling the
options carrot. According to sources, there are companies that
have decided to mount a selective salvage operation for key employees,
but are chary of going public with the move.
Can't blame them. It's bad enough that employees who had compromised
on their fixed compensation to take Esops might be getting restless.
Finding out that their employer is now playing favourites might
not go down too well.
- NAVJIT GILL