CANADA: Option repricing at issue - 3 June 2009

Option repricing at issue

Canada Resists; Falling shares present problem for compensation

Julius Melnitzer,
Financial Post 

Published: Wednesday, June 03, 2009

Earlier this year, about 71% of Fortune 500 companies had stock
options that were underwater, which is to say that on average the
exercise price was higher than the current share price.

In corporate terms, that makes for the perfect storm.

"Employees
are uninspired by their equity compensation, institutional shareholders
are unhappy about share values and companies are somewhat handcuffed in
remedying the situation because outstanding underwater or drowning
options count against shares reserved under an option plan," says Dov
Begun, a lawyer at Osler, Hoskin & Harcourt in Toronto.

In
the United States, more than 100 companies have addressed the issue in
the last 18 months by repricing options, but it's unlikely the
repricing trend will be as prevalent in Canada.

While the TSX
does not require shareholder approval of repricing programs unless
insiders stand to benefit, Canadian companies seem much more prone than
their U. S. counterparts to encounter the wrath of shareholders.

"There's
a much stronger antipathy to repricing stock options here than there is
among shareholder activists in the U. S.," says Christina Medland, a
lawyer at Torys in Toronto.

For example, RiskMetrics Group, a
proxy advisory firm, has indicated it will generally vote against
repricing in Canada when it occurs without shareholder approval, with
some limited exceptions. But in the United States, it takes a
case-by-case approach that weighs a number of considerations, such as
the historic trading patterns of the stock and the rationale for the
exchange.

Many powerful Canadian institutional investors are also
opposed to repricing. OMERS' proxy voting guidelines, for example,
state that the fund will vigorously oppose altering stock options in
any way when stock prices fall. Ontario Teachers' Pension Plan, CPP
Investment Board, Canadian Coalition for Good Governance, Public Sector
Pension and Investment Board, British Columbia Investment Management
Corporation and Ethical Funds all have similar policies.

"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," Ms. Medland explains.

So far repricings have been few and far between in Canada.

"The
few examples I've seen of companies repricing without shareholder
approval have been issuers on the TSX Venture Exchange," says Mr.
Begun's partner Andrew Mac-Dougall. "The one exception is GMP Capital
Trust, which repriced in the process of converting from a trust to a
corporate structure-- something that makes sense in a start-afresh
scenario because you don't want old trust options hanging around the
new corporation."

Aggravating the conundrum is the tax treatment that options receive, which is akin to capital gains treatment.

"Of all the ways of compensating people, options are the best from a tax perspective," Mr. MacDougall says.

And in this economy, more cash compensation is hardly a preferred alternative.

"Most companies don't have a lot of cash for bonus plans," Ms. Medland says.

What
may be more appealing to all stakeholders than a cash bonus or a
straight repricing is exchanging the existing options for a smaller
number of new options at a lower exercise price. That's a route
proposed recently by various U. S. issuers, including Starbucks Corp.
and Motorola Inc.

"Because there's no additional cost to the
employee for the exchange, the new options have value no matter where
the stock price goes, unless the company goes bankrupt," Mr. MacDougall
notes.

"And because each optionee receives fewer stock options
than were cancelled," he says, "the number of outstanding options
decreases, thereby reducing the company's stock option overhang, which
is a measurement used to determine the dilutive effect of options."

Interestingly,
providing a value-for-value exchange of this kind is one, but only one,
of RiskMetrics' conditions for voting in favour of repricing in Canada.

Finally, properly done, the exchange can be effected without Canadian tax consequences.

Still, it may be awhile before the repricing phenomenon, in whatever form, takes hold in Canada.

"The companies in the most serious financial trouble

http://www.financialpost.com/news-sectors/legal/story.html?id=1656756