To the very large gallery of bull market creatures whose recent woes should elicit sympathy from no one, add holders of "underwater" stock options. It was not so long ago that having stock options--particularly options granted by a technology company, and especially those granted by Internet companies with rocketing share prices--was the coolest thing imaginable. There was an air of free money around stock options, and naturally a certain amount of envy developed alongside them. But those lucky ones who had amassed killer options packages assured the rest of us that this was because they had taken a risk, forgoing the safe road of an all-cash salary and leaving part of their compensation up to the market. They'd bet their future on high tech, and if they'd been proved visionaries and richly rewarded by the market, well, they damn well deserved it.
Fine. But what happens when they are not proved visionaries by the market after all? What happens, in fact, when the market comes to, shall we say, the opposite conclusion? In these instances, it turns out, the "risk-takers" typically discover that the market can be second-guessed after all, and that those underwater options should be re-priced. A hypothetical example: Say Example Inc. grants stock options to new employees with a strike price of $10 a share. If Example's stock price rises to $15, employees can cash in and pocket the $5-a-share difference; if Example gets hyped on CNBC, becomes popular with day traders, and explodes to $100 a share, then employees fare that much better. But if Example gets caught in the downdraft and falls to $5, then the options are worth nothing: They are underwater. It is at this point that option victims often feel a re-pricing is in order, lowering their strike price to, say, $2 a share, so they can at least get some kind of payoff for their hard work. Suddenly the options score is seen not as a reward but as a right.
Earlier this year, CDNOW and Barnesandnoble.com, both e-tailers whose share prices have been stomped, reportedly announced plans to re-price underwater options. And just last week, of course, Microsoft granted new options, priced at about $66 a share--the previous day's closing price--to all its workers. (Issuing new options is slightly different from re-pricing existing ones, but the effect is basically the same.) Obviously, the idea here is to protect those workers from paying the price for what the company sees as the market's bad judgment (and thus to keep those workers from fleeing out the door). Because these actions are aimed at wider swaths of employees, they are somewhat more intellectually defensible than re-pricings of executive option packages, a practice that has gone on for years.
But it's not that much more defensible. In fact, the re-pricing or new issuance of options on a wide scale seems more like evidence of a double standard in the way that option-hungry workers think about the markets. After all, if you are going to justify your rewards by saying that you are taking a risk, then you have to actually take the risk. Either that, or adopt a way of thinking about stock market incentives that somehow accounts for all of the market's more spurious judgments, on the upside as well as the downside. But I don't think any of the employees of Example Inc. who saw the company's share price rocket from $10 to $100 on no news would particularly welcome a decision by Example management to re-price their options to $90 a share because the market was so obviously off the mark.
Re-pricings would probably be happening on a far larger scale if not for a somewhat recent change in accounting rules that lets companies ignore options grants on their balance sheets but forces them to account for re-pricings. This new rule has, not surprisingly, drawn objections from companies that issue options to lots of employees. To a certain extent, the new rules do in fact favor big, cash-hoarding outfits, which can afford to manage the costs of such maneuvers more easily than smaller companies that are eking out their first profits. Then again, it's still those smaller upstarts that maintain the greatest promise for massive share prices gains over time, assuming they build business models that let them grow into real, profitable companies. Which ones will actually do that is hard to guess. And therein lies the risk, and the reward.