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Underwater Options   
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Basics: Underwater Options

How have the stock-market volatility and economic fluctuations of recent years changed stock grant practices?

Changes in executive compensation and equity pay practices stemming from the downturn of 2008 and 2009 were far more extensive and vigorous than those caused by the 2000–2002 market drop. More companies were affected by the market crash in 2008–2009, which was accompanied by a steep rise in unemployment. Moreover, stricter rules on disclosure and shareholder approval of stock plans and executive compensation were already in place by 2008.

In general, during the recovery since 2009 the focus in stock compensation has shifted from adjusting grant practices for mandatory expensing to re-examining the uses of equity awards, particularly performance-based grants. Companies continue to decrease their use of stock options in favor of restricted stock/RSUs and performance share grants. The advantages offered by ESPPs have made them also appealing for broad-based use by companies.

Adjustments In Grant Sizes

Some companies have reconsidered the valuation approach they use to determine the size of new stock grants. Many companies base grant sizes on either a target amount of compensation or a target number of shares (see related FAQs on these grant guidelines for stock options and restricted stock). In down markets, one problem for many companies is whether to adjust the target dollar value of stock grants (converted into a specified number of shares/options/units) or to adjust grants that are usually a fixed target number of shares. Under the target value method, lower stock prices means companies need to grant many more options or shares to reach a target value. This, in turn, uses up shares much faster (i.e. increases the burn rate), raises dilution concerns, and creates too large a gain for executives if the price rises quickly. However, the target size approach, without an adjustment in the size, results in a grant with a much lower value.

Survey Data On Grant Trends

A related FAQ features survey data about the effects that expensing, stock-market trends, and other developments have had on equity compensation.

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