Underwater Exchange Approaches

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Three basic approaches have emerged for addressing underwater options in today's business environment: Options-for-Options, Options-for-Stock, and Options-for-Cash. The form of consideration offered by the company in return for the employee's participation is the primary difference between the alternatives. Figure 2 provides a general description and outlines the advantages and disadvantages of each approach. For a detailed discussion of how to design and implement one of these exchanges, read our white paper Addressing Underwater Options: Measured Responses to a Contentious Problem on this topic.

Descriptions of Underwater Exchange Approaches:

Exchange Approach	Description	Advantages	Disadvantages
Options-for-Options	Cancellation of underwater options followed by an immediate re-grant of (typically fewer) new options	Ease of communication (employees generally understand options) Some reduction in issued stock overhang (assuming fewer new options are granted than were cancelled)	Potential remains for newly issued options to go underwater in the future May not be received positively by employees if stock options have not provided value historically
Options-for-Stock (restricted stock or RSUs)	Cancellation of underwater options followed by an immediate re-grant of (significantly fewer) new shares of restricted stock/units	Eliminates additional future underwater options (restricted stock cannot fall underwater) Greater reduction in issued equity overhang due to higher exchange ratios	Employees lose control of taxable event (shares taxed at vest/receipt) Number of shares returned to employee typically reduces future upside leverage compared to using stock options
Options-for-Cash	Cancellation of underwater options for a (typically immediate) cash payment	Greatest possible reduction in issued equity overhang (no new equity shares are issued) Eliminates additional future underwater options Typically provides immediate value to participants when no additional vesting required for payment	Requires a cash outlay by the company Employees lose control of taxable event (taxed upon payment) Employees lose opportunity to participate in future upside stock price growth Lacks retention features if no additional vesting added