Canceling & Reissuing Stock Options

With the recent bear market declines, many employees that have had part of their compensation tied to company stock options have seen them go way out-of-the-money, which is often referred to as being "underwater." This has prompted many companies to go through a process that cancels and reissues the stock options. There are a variety of conditions that have to be met along with some tasks that have to take place to actually implement this process.

Employee Stock Options Definition

1. Companies use stock options as a part of an employee compensation package. An employee stock option is comprised of a call option on the company's underlying stock where basically the employees will financially benefit from these options if the company's stock goes up in value.

The Objective of Issuing Stock Options

2. The idea or objective of issuing stock options is to instill business behavior in employees that will help the underlying stock price to increase.

Why Are Stock Options Canceled and Reissued?

3. The rationale behind a company's decision to cancel, reprice and reissue employee stock options is that when a company's stock has been hit and previous options that were issued are out-of-the-money, they are basically worthless. To keep employees happy and productive, companies started the practice of canceling and reissuing these stock options at a much more favorable strike price.

The Process of Issuing Stock Options

4. The process of originally issuing employee stock options involves an approval by the company's board of directors to allow the employee to buy the underlying stock at a specific price known as the strike price.

The Process of Canceling and Reissuing Stock Options

5. When the stock options go underwater, the company can implement the process of canceling and reissuing these stock options. This involves the company's board approving that the designated options will be canceled and reissued at a better strike price.
   
   Keep in mind the decision to do so is not as easy as it once was. In 1998 the Financial Accounting Standards Board (FASB) tried to discourage this process by making companies incur an expense if they elect to go through with the canceling and reissuing process. In fact, what usually has to happen now is that the options have to be very deep underwater to the point there is no practical way the price will recover in the number of trading days tied to the option before expiration. Otherwise, the company will probably not initiate the stock option canceling and reissuing procedure.