National Post (Latest Edition)

OPTION REPRICING AT ISSUE

CANADA RESISTS Falling shares present problem for compensati­on

- BY JULIUS MELNITZER Financial Post

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 are the ones most likely to reprice, but companies who think they can weather the current crisis are riding it out in the hope that their share price will come back,” Ms. Medland says.

“The vast majority — the ones in the middle — have just got through the annual meeting season, and the last thing they want is a special meeting so they can get the shareholde­r approval required.”

Everyone’s waiting for breathing time, it seems. Whether that will come soon enough in any particular case is anybody’s guess.

 ?? BRETT GUNDLOCK / NATIONAL POST ?? Andrew J. MacDougall, left, and Dov Begun, of Osler Hoskin & Harcourt: Few repricings seen in Canada so far, they say.
BRETT GUNDLOCK / NATIONAL POST Andrew J. MacDougall, left, and Dov Begun, of Osler Hoskin & Harcourt: Few repricings seen in Canada so far, they say.

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