ASX-listed and unlisted public companies in Australia are experiencing:

• a significant decline in their share price
• the effects of the Ukraine conflict and macro-economic factors impacting the economy
• the tight executive talent market making it difficult to retain talent
• share options granted in better times now being well out of the money becoming a disincentive rather than incentive
• boards and management coming under pressure to address this mismatch

While repricing options has been more common in the US (a total of 264 stock option repricings were announced between 2004 and 2009) it has been less so in Australia. There are reasons for this, discussed below. Nevertheless, the demotivating effect of underwater options still lands on the board agenda in difficult times.

Here are some things the Chair of the Remuneration Committee will need to check off when the issue does arise.

ASX-listed company board checklist

The most significant issue for ASX-listed company RemCo chairs is what they can, and cannot do under the Listing Rules.

1. You do not need shareholder approval to cancel an option for no consideration (ASX LR 6.23.1). So, that’s easy, cancelling an option for no payment. But, why would the executive agree to this? It is reasonable to expect the executive/s will, at least, want a replacement grant. Be careful, as that would be consideration for the cancellation.
2. Cancelling options for consideration can only be made if shareholders approve the change (ASX LR 6.23.2). However, care is needed as explained in (3) below.
3. Making a change to options that has the effect of reducing the exercise price, increasing the exercise period, or increasing the number of securities cannot be made (ASX LR 6.23.3). This is significant because it is prohibited, even with shareholder approval! If, for example, the company has shareholder approval to cancel options for replacement options as in (2) above, the transaction as a whole potentially falls under this LR and is prohibited.
4. A change to options that is not prohibited by ASX LR 6.23.3, can only be made with shareholder approval. Although, we struggle to come up with what other change can be contemplated to achieve the objective (ASX LR 6.23.4).
5. The above rules do not apply to changes made to comply with the Listing Rules such as capital reorganisations (ASX LR 6.23A).

It can be seen from the above that there is much to be considered if an ASX-listed company board is under pressure to address out of the money options.

While there are other commercial and accounting issues to consider, there is an important tax implication that should not be overlooked.

If an employee is holding options under the employee share scheme rules of the tax legislation that are cancelled for consideration, that transaction will most likely crystallise a taxing point for the employee. The employee would be taxed at their marginal tax rate on the value of the consideration (that is, the value of the replacement equity).

Unlisted public company board checklist

Dealing with underwater options can be easier for unlisted public companies, or even large private companies.

1. Firstly, and to state the obvious, the unlisted company is not subject to the Listing Rules.
2. It is, however, subject to the company’s constitution and/or Shareholders Agreement. These should be checked to determine what can and cannot be done under the constituent documents. They will likely specify that shareholder approval is required within limits.
3. The board may look to reduce the exercise price to the current share value. If so, care needs to be taken to ensure any change does not have the effect of cancelling the old options in exchange for new options. That would be a taxing point for the employee.
4. A cancellation of options for consideration will be a taxing point for the employee as the old options are disposed of for the value of the replacement equity. This may be a desired outcome but certainly needs to be fully considered.
5. The cancellation or modification of underwater options will have an accounting implication for the financial statements. There is likely to be a charge to the P&L.

The lesson as we go through these challenging times, is to fully consider the equity grants that are to be made, and not lose sight of the fact that, in most cases, employees are eligible for annual grants of equity. Annual grants of equity go a long way to ameliorating the adverse implications of a changing business cycle.

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