Underwater Exchange Approaches

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. The table below 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

Description Advantages Disadvantages
Approach 1: 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
Approach 2: 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
Approach 3: 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