How Should I Handle Lower Stock Prices?

Stock price fluctuations can significantly impact the value of equity compensation for employees, leading to frustration or disengagement due to the decrease in value of their equity compensation. As an employer, it's essential to be proactive in managing these situations, especially when equity is a key component of your compensation and employee retention strategies.

This article will explore how to handle declining stock prices in relation to equity compensation and help guide you on how to maintain employee motivation and retention, while also preserving the integrity of your compensation programs.

The Impact of Lower Stock Prices on Equity Compensation

Equity compensation, whether in the form of stock options, restricted stock units, or performance awards, can lose significant value when a company's stock price declines. Employees may start to feel that their compensation is not delivering the expected financial reward, which can result in low morale or even lead employees to explore other opportunities.

Stock options are particularly vulnerable. When the exercise price of stock options exceeds the current stock price, these options are said to be "underwater." Although there’s always the possibility that stock prices may rebound, underwater stock options lose their perceived value, reducing the incentive for employees to stay and contribute.

But the impact isn't limited to just stock options. Full-value equity awards, such as RSUs, also decline in worth alongside the company stock price. Performance awards can be affected similarly, especially if they were granted based on a specific target value that’s no longer realistic.

In light of these challenges, here are some strategies to help mitigate the negative effects of a declining stock price on your equity compensation programs:

1. Give the Stock Price Time to Recover

One of the least disruptive approaches to handling lower stock prices is to wait it out. Stock prices often fluctuate, and immediate action may not be necessary. A rushed response, such as a quick repricing or issuing new grants, can be costly and may not offer a long-term solution if market conditions remain volatile.

Taking a "wait-and-see" approach allows for the possibility of a recovery, avoiding hasty decisions that could lock in unfavorable terms. That said, this approach requires a balance and If the stock price continues to decline, you may need to consider alternative strategies, especially in competitive industries where employees may feel the pressure to leave for greener pastures.

2. Issue Additional Grants

If your company has sufficient shares available in its reserve, issuing additional grants is a straightforward way to restore some of the value employees feel they’ve lost. This approach doesn’t require modifying existing equity awards or gaining shareholder approval, which makes it less complex from a compliance standpoint.

However, issuing new grants can come with its own set of challenges. New grants increase overall dilution and equity burn rate, which may not sit well with shareholders. The additional expense also impacts the company’s financials, which may already be under strain in a down market.

Before proceeding with this option, it’s important to evaluate the long-term implications for your company’s equity plan and ensure you have a clear strategy for how these new grants will be perceived by employees and shareholders alike.

3. Exchange Underwater Options for New Awards

Another strategy to restore value for employees is to offer an option exchange, where underwater options are canceled and replaced with new ones at a lower exercise price. This can be a more cost-effective solution compared to simply issuing new grants, as the canceled options can offset some of the expense.

For publicly traded companies, option exchanges often require shareholder approval and are subject to proxy advisor guidelines. The SEC may also require companies to file a tender offer in certain cases, adding a layer of complexity to the process.

Option exchanges can take different forms:

• Straight Repricing: Underwater options are simply reissued with a lower exercise price, but this is typically the most costly approach.
  
• Value-for-Value Exchange: Underwater options are canceled in exchange for a smaller number of new options with a similar fair value, reducing the overall cost to the company.
  
• Options for Full-Value Awards: Employees relinquish underwater options in exchange for full-value awards, such as RSUs, which may be more attractive in a declining market due to their retention of at least some value even as the company stock price drops.

Each of these alternatives comes with specific regulatory and accounting requirements, so it’s important to carefully consider the best fit for your organization.

4. Offer a Cash Incentive

In some cases, offering a cash incentive in addition to or instead of equity compensation may be an option. While this requires a sufficient cash reserve and can strain the company's finances, it may be a viable way to alleviate employee concerns over the declining value of their equity awards.

It’s important to note, however, that while the NYSE and Nasdaq generally don’t require shareholder approval for equity award exchanges for cash, the company's specific equity plan may still have provisions that do. Furthermore, ISS often views cash exchanges for underwater stock options as a form of repricing and will typically issue an unfavorable recommendation for plans that bypass shareholder approval for these transactions.

5. Utilize Your Employee Stock Purchase Plan (ESPP)

If your company offers an Employee Stock Purchase Plan (ESPP), this could be a great opportunity to highlight the program. ESPPs, especially those with a discount feature or lookback provision, can provide a guaranteed gain for employees, even in a down market.

If you don’t already offer an ESPP, now may be the time to consider implementing one. A well-structured ESPP can encourage employee retention and provide a meaningful financial reward, even when stock prices are low.

NASPP Resources: 

Handling lower stock prices is a delicate process that requires balancing the needs of the company, its shareholders, and its employees. While it can be tempting to act quickly to address underwater options and declining equity values, taking the time to carefully evaluate your options will lead to more sustainable solutions.

Whether you decide to wait for a market recovery, issue new grants, explore option exchanges, or offer cash incentives, the key is to communicate openly with your employees. By keeping them informed and demonstrating a long-term commitment to their financial well-being, you can help mitigate the negative effects of a declining stock price while maintaining their engagement and loyalty.

And for those attending the annual conference in SF this year, please make sure you aren't missing out on the Panel Discussion - Mastering Share Pool Dynamics: Strategies for Volatile Markets

In this session, you'll dive into the importance of strategic equity usage and effective share pool management, especially in volatile markets. You’ll hear real-world examples and proven strategies to help you craft a share request that extends the life and impact of your equity pool.

Experts from BlackRock will share insights on equity usage, dilution, and how share requests are viewed from an institutional shareholder’s perspective. Additionally, you'll explore practical solutions for managing equity plans when share availability is limited, including innovative long-term incentive (LTI) designs.

By the end of the session, you'll have actionable market data, a clear process, and practical tips that you can immediately apply to your organization’s equity management efforts.