September 28, 2022

Addressing Underwater Stock Options

Holland & Knight Alert
John D. Martini | Victoria H. Zerjav | Nicole F. Martini


  • Given the significant decline in the stock prices of many companies over the past several months of 2022, a number of companies are reassessing their equity programs and considering repricing outstanding employee stock options.
  • Companies are concerned that significantly "underwater" options no longer provide the incentives to employees that were intended when they were originally granted, and they also fear they may lose employees to other companies where these employees can receive new options at today's lower exercise prices.
  • This Holland & Knight alert offers recommendations on how to address underwater options.

Given the significant decline in the stock prices of many companies over the past several months of 2022, a number of companies are reassessing their equity programs and considering repricing outstanding employee stock options.1 Companies are concerned that significantly "underwater" options no longer provide the incentives to employees that were intended when they were originally granted. They also fear they may lose employees to other companies where these employees can receive new options at today's lower exercise prices.

Addressing Underwater Options

When deciding how to address underwater options, companies should keep the following considerations in mind:

  • Accounting. Under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718 – Stock Compensation, an accounting charge may be incurred based on the approach taken.
  • Section 409A. New options must be structured so that they are either exempt from or compliant with Section 409A of the Internal Revenue Code of 1986, as amended (Section 409A).
  • Recognition of Ordinary Income. Depending on the approach taken, option holders may lose their ability to control the timing of a taxable event.
  • Incentive Stock Options. Option repricings involving incentive stock options (ISOs) raise certain tax issues. First, if an option is repriced, the adjustment will be considered a new option and will give rise to a new grant date for purposes of the ISO holding periods set forth in Section 422 of the Internal Revenue Code. Second, Section 422(d) of the Code provides that ISOs will be treated as non-qualified stock options (NQSOs) to the extent that the aggregate fair market value of the stock with respect to which ISOs are exercisable for the first time during any calendar year exceeds $100,000. In a repricing, if the exercisability of the prior option is carried over to the new option, the new option may cause the aggregate ISOs vesting in that year to exceed the $100,000 limitation.
  • Shareholder Approval. Whether shareholder approval is required depends on the approach taken and the terms of the equity plan document. See also the below regarding shareholder considerations.
  • Tender Offer. The S. Securities and Exchange Commission (SEC) has taken the position that a stock option repricing in the form of an exchange program that allows employees to surrender existing, out-of-the-money options for new, lower-priced options involves individual investment decisions and, therefore, constitutes an issuer tender offer. As a result, these exchange programs are subject to Rule 13e-4, the issuer tender offer rule, which, among other things, requires the filing of a Schedule TO with the SEC and the dissemination to option holders of the disclosure documents specified by the rule. In addition, the issuer must also comply with Regulation 14E, which places restrictions on the conduct of tender offers and requires all tender offers to remain open for at least 20 business days. These requirements will add significant costs and time delays to the process of conducting these exchange programs.

However, the SEC issued an exemptive order for issuer exchange offers that are conducted for compensatory purposes, which generally eliminates the following tender offer requirements:

  • the "all holders" rule, which requires that the tender offer is open to all holders of the share class subject to the offer, and
  • the "best price" rule, which requires that all holders in a tender offer be paid the same price

In order to qualify for this exemption, the exchange offer must meet the following four conditions:

  • the issuer is eligible to use Form S-8, the options subject to the exchange offer were issued under an employee benefit plan, and the new options offered in the exchange will be issued under such a plan
  • the exchange offer is conducted for compensatory purposes
  • the issuer discloses in the offer to purchase the essential features and significance of the exchange offer
  • except as exempted by the order, the issuer complies with all requirements of Rule 13e-4

If the repricing is only offered to a small number of executives, however, the repricing is unlikely to be considered a tender offer.

Addressing Out-of-the-Money Options

Companies may consider one or a combination of the following Options 1-4 to address stock options that are no longer in the money.

Option 1: Straight Option Repricing

Mechanism. The employer reduces the exercise price of the option to the fair market value of the stock as of the date of the repricing. The employer accomplishes this by either amending the outstanding options to change the exercise price or canceling the outstanding options and issuing new options with the lower exercise price.

Shareholder Approval. Companies should look to their equity plan documents to determine whether an option repricing may be effected without shareholder approval. If the company is public, the plan document must explicitly state that repricings are permitted without shareholder approval; if the plan document is silent, New York Stock Exchange (NYSE) and Nasdaq listing standards treat the silence as prohibition. Public companies must also file a proxy statement, and if new securities are granted to named executive officers and/or Section 16 insiders, the company must file Form 8-K and/or Form 4, respectively. It is common in plans for private companies that no shareholder approval would be required, but in addition to the plan documents, shareholder agreements should be reviewed.

Tax Impact. If an option is canceled and a new option is issued or the original option is repriced, there is no tax event. In order for the new option or repriced option to remain exempt from Section 409A of the Code, the exercise price of such option must be at least equal to or greater than the fair market value of the stock underlying the option at the time of grant or repricing, as applicable.2

Accounting. FASB ASC Topic 718 – Stock Compensation states that an option exchange is a modification of the original option. Because a straight option repricing increases the value of the option (or replaces an option with a higher-value option), an accounting charge is incurred. While this may not be a concern for a private company, this can be meaningful for a public company.

Option 2: Value-for-Value Exchange

Mechanism. The employer issues new options in exchange for the underwater options at a ratio of less than one-to-one. The new grant has a fair value (using a method such as Black Scholes) equal to or less than the value of the original grant.

Shareholder Approval. The shareholder approval requirements for a value-for-value exchange are the same as the requirements for a straight option repricing. Shareholders and (for public companies) proxy advisory firms prefer the value-for-value exchange because dilution and compensation expense are minimized.

Tax Impact. The tax implications of a value-for-value exchange are the same as the tax implications for a straight option repricing.

Accounting. Because the value of the options (in the aggregate) either remains the same or decreases, no accounting charge should be incurred.

Option 3: Exchange for Other Equity

Mechanism. The employer cancels outstanding options and grants another equity award (often restricted stock or restricted stock units) with equal or lower value as a replacement.

Shareholder Approval. The shareholder approval requirements for an exchange for other equity are the same as the requirements for a straight option repricing.

Tax Impact. Option holders are generally taxed at the time the new awards of restricted stock or RSUs vest. If the holder makes an 83(b) election with respect to an award of restricted stock, the holder is taxed on the grant date.

Accounting. Because the value of the award (in the aggregate) either remains the same or decreases, no accounting charge is incurred.

Option 4: Cash Buyout

Mechanism. The employer cancels outstanding options in exchange for a cash payment.

Shareholder Approval. Shareholder approval is unlikely to be required. Plan documents and shareholder agreements should be reviewed.

Tax Impact. Option holders are taxed at the time of the cash-out.

Accounting. The company recognizes an expense for any vested portion of the option (to the extent unexercised) equal to the greater of the settlement fair value or the original grant date fair value and the expense for any unvested portion is recognized immediately (to the extent that it has not yet been amortized). If the cash payout exceeds the current fair value of the award, the excess is recorded as an additional compensation cost.

Proxy Statement Disclosure

Public companies subject to the proxy statement requirements of Section 14 of the Securities Exchange Act must include in any proxy statement containing executive compensation information detailed disclosures concerning option repricings effected during the last fiscal year that included the executive officers listed in the various compensation tables contained in the proxy statement, also known as the "named executive officers." The required disclosures include:

  • a report of the compensation committee explaining the terms of the repricing and the basis for the repricing
  • detailed tabular information concerning all repricings of options held by any executive officer during the last 10 fiscal years.

Of course, if an option repricing program excludes the named executive officers, this disclosure is not required.

Under the SEC's new pay versus performance disclosure rules, companies will need to carefully consider how an option repricing or exchange will impact how they calculate the value of equity awards. The value of the equity awards would be included in the calculation of compensation actually paid to the named executive officer.

Shareholder and Other Related Concerns

Implementation of an option repricing program often generates a negative backlash from shareholders (particularly in public companies, but this is also a concern for private companies) who have seen the value of their holdings diminish, who fear addition dilution from the outstanding options and who believe repricings diminish the goal of aligning shareholders' and management's interests. Shareholder opposition to option repricings creates a risk of shareholder lawsuits. These lawsuits will generally allege a waste of corporate assets based on the grounds that the company has received no benefit from the repricing.

Other negative implications of option repricings include:

  • sending a signal to the market that the company does not expect to achieve its previous stock price
  • sending a message to employees that performance of the company's stock is not important because management can always reduce option exercise prices whenever necessary
  • creating the impression that employees do not face the same risks as the company's shareholders, who, of course, cannot reprice their stock holdings

In response to shareholder concerns, companies that decide to go forward with a repricing program may wish to consider implementing one or more of the following approaches:

  • obtain shareholder pre-approval of any particular repricing program, or at least of the outer boundary terms of any future option repricings
  • exclude executive officers and directors from the repricing program
  • provide employees with fewer repriced options in exchange for their underwater options
  • reprice only a portion of the underwater options
  • adjust the vesting provisions of the new grants


While option repricings or similar restructuring of equity awards may be a very meaningful way to readjust and right size incentive programs in a down market, any repricing or restructuring should be done only after consideration of the requirements and the risks involved so the issuer is fully prepared to respond to any questions or contests of the decision.

If you have any questions about your company's equity incentive plans, please contact the authors, another member of Holland & Knight's Executive Compensation and Benefits Team or your primary Holland & Knight attorney.


1 While it is more common to hear of public companies repricing options, private companies can and do reprice options as well.

2 Repricing an option several times may create a risk that the exercise price is treated as variable instead of fixed for purposes of Section 409A of the Code.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.

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