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Stock option repricing considerations in the COVID-19 era

Author(s): Lynne Lacoursière, Dov Begun, Colena Der, Alain Fournier, Andrew MacDougall, Kelly O’Ferrall

Apr 15, 2020

For further information on the changes below, please contact one of the authors above or any member of our National Employment, Executive Compensation or Tax Advisory Services Groups.

The COVID-19 pandemic and the increasingly stringent governmental efforts to contain its spread have had a devastating impact on businesses. That impact has resulted in a steep and widespread drop in share prices, causing the worst crash the TSX has seen in 80 years,[1]  wiping out gains made over the last two years on the Canada S&P/TSX Toronto Stock Market Index and rendering worthless many option grants made over the last few years. 

In some industries employees are being asked to go above-and-beyond normal expectations to support containment efforts and essential services, while other businesses have reduced or closed operations and are looking at reductions in staffing and compensation to conserve cash resources in order to survive.  Increasingly, cash-strapped companies are looking at restructuring their stock option programs as part of a solution to keep active employees engaged and to retain key employees while conserving cash.

This article outlines considerations for companies that are contemplating changes to their stock option programs to address underwater or out-of-the-money stock options (i.e., stock options for which the share value is less than the exercise price of the option).

The board’s role

In determining whether or not to modify any equity compensation program as a result of a decline in the company’s share price, directors must have regard to their fiduciary obligations to act honestly and in good faith with a view to the best interests of the company. In considering what is in the company’s best interests, directors may look to the interests of its stakeholders, including employees and shareholders. While courts will accord deference to directors’ business decisions, directors will only be protected from liability to the extent that their actions evidence the exercise of business judgment. Boards should be diligent in their deliberations and thoroughly document the discussions surrounding them. Boards should also consult with experts, such as accountants and legal counsel, regarding the expected costs and benefits of the various alternatives.

A defensive approach to decision making is particularly important when considering whether to permit employee option holders to fare better than shareholders when the company’s stock price falls. In deciding whether to modify a company’s stock option program, the board should examine whether the purposes of the existing program are being met. This analysis may turn on, among other matters:

  • the probability of outstanding options becoming in-the-money prior to expiry;
  • the extent to which outstanding options represent a substantial portion of employee annual compensation and cumulative employee financial wealth;
  • the relative levels of risk and cost associated with losing employees during the current pandemic and replacing them as the economy recovers;
  • the presence or addition of other features to the program that are favourable to the interests of the company (such as longer vesting schedules, forfeiture, claw-back or repayment obligations in the event of a financial restatement or breach of a non-competition covenant, double trigger change of control provisions, etc.); and
  • the impact on the company’s share reserve and the timeline for seeking shareholder approval for an increase in the reserve.

The board should also consider the pros and cons of the alternatives available to the company, some of which are described in this article.

Option repricing

Companies have struggled before with how to handle underwater stock options. For example, in the aftermath of the financial crisis in 2008, many companies modified and restructured their stock option programs[2] either through re-pricing options, granting additional options or replacing out-of-the-money options with restricted stock or restricted share units. In the year following the 2008 financial crisis, almost 100 companies re-priced their outstanding options, including eBay, Starbucks, Motorola and Williams-Sonoma.[3] Although the current circumstances in light of COVID-19 are unprecedented, there is certainly ample precedent for re-pricing.

What is repricing?

Option re-pricing can be effected through reducing the exercise price of existing options to the current market price of the underlying shares, either by amending the grant agreement or by allowing option holders to surrender their underwater options for cancellation in exchange for new options (this is generally referred to as one-for-one or straight option re-pricing). Re-pricing can also be achieved by cancelling the underwater options and issuing new options over a smaller number of shares with a lower exercise price, such that the value of the new options is equal to or less than the value of the underwater options (often referred to as a value-for-value exchange). In a value-for-value exchange, because each optionee receives fewer options than the number of options that were cancelled, the number of outstanding options decreases, thereby reducing the company’s stock option overhang — i.e., the potential dilutive effect of outstanding options.

Stock Exchange requirements

The Toronto Stock Exchange (TSX) requires shareholder approval of any re-pricing of options affecting insiders, regardless of the terms of the plan.[4] If a company’s option plan contains amendment provisions approved by shareholders that permit re-pricing of outstanding options held by non-insiders, then the TSX will not require shareholder approval for the re-pricing of such options. However, few plans provide this flexibility as Institutional Shareholder Services (ISS), a proxy advisory firm, will automatically recommend against approval of any plan if the amendment provision permits a reduction in exercise price or cancellation and reissue of options or other entitlements. The level of shareholder approval required is majority approval, excluding the votes of the insiders who will benefit. The TSX will consider any cancellation and reissuance of options to insiders under different terms to require such approval, unless the reissuance occurs at least three months after the related cancellation. These principles may also apply to Canadian companies that are foreign private issuers listed on the New York Stock Exchange or The NASDAQ Stock Market, who are permitted to follow their applicable home country practices with respect to revising their equity compensation plans, and there may be significant relief from the application of the U.S. tender offer rules.[5]

Companies listed on the TSX Venture Exchange (TSX-V) must obtain approval from the TSX-V of any reduction in the exercise price of a stock option, including any cancellation and reissuance of options to the same person within a one-year period. For any amendment to reduce the exercise price of an option, the TSX-V requires that at least six months must have elapsed since the later of (i) the grant date, (ii) the date the company’s shares commenced trading, or (iii) the date of the last amendment to the exercise price of the option. The TSX-V also requires that plan amendment provisions state that shareholder approval by a majority of disinterested shareholders is required to reduce the exercise price of options held by insiders. TSX-V-listed companies also need to consider applicable rules regarding minimum exercise prices and hold periods.

Proxy advisory firms and option repricing

Even if shareholder approval is not legally required to implement a repricing program, companies may be leery of proceeding without such approval given investor antipathy to such programs and the adverse publicity the introduction of such programs can generate (click here for an example from 2009). Many institutional shareholders and proxy advisory firms have taken strong positions against repricing programs.

In Canada, ISS generally recommends voting against proposals to reprice outstanding options. ISS takes the position that plan amendment provisions for both TSX- and TSX-V-listed companies must require shareholder approval for all option repricings, regardless of whether the affected options are held by insiders. ISS will recommend voting against any new plan if the company has repriced options without shareholder approval within the last three years. ISS’s rationale for the position is that stock options are meant to be an at-risk form of compensation, and the inherent incentive value of stock options is weakened if the exercise price of underwater options can simply be reduced to temper the impact of a falling share price.

Glass Lewis, another proxy advisory firm, states in its Canadian proxy voting guidelines that it is firmly opposed to the repricing of employee and director options regardless of how it is accomplished.  However, it acknowledges that option repricing may be appropriate, provided that: (i) the stock decline mirrors the market or industry price decline in terms of timing and magnitude, (ii) the new exercise price and terms are reasonable, and management has provided a thorough explanation as to how such terms were decided and (iii) management and the board make a cogent case for needing to incentivize and retain existing employees. Glass Lewis has already foreshadowed shareholder concerns about option repricing proposals in response to falling share price due to COVID-19, stating “The stark reality is that for many workers, including executives, they should not expect to be worth as much as they were before the crisis, because their free market value as human capital has now changed.”[6]

Disclosure implications

Companies contemplating a repricing program should also bear in mind the following disclosure obligations:

  • if shareholders vote on the program, a detailed description of the proposal must appear in the meeting materials circulated prior to the vote;
  • for TSX-V issuers, if the amendment affects one or more insiders, the issuer must disclose the amendment by press release, specifying the names and option holdings of any affected insiders;
  • for TSX issuers, a summary of any amendment to the plan or an option must be described in the company’s information circular for its annual shareholder meeting the following year; and
  • if named executive officers or directors take part in the program, detailed information about their participation in it must be included in the company’s executive compensation disclosure.[7]

Insider trading considerations

Companies who do reprice options need to be careful that any new exercise price for the options is not based on trading prices established at a time when the company was in possession of material information that had not been generally disclosed. Both the TSX and the TSX-V prohibit such pricing and Canadian securities regulators have pursued enforcement proceedings in some cases where options were priced to take advantage of undisclosed material information.

Private company considerations

Different considerations will apply to private companies who are contemplating repricing. Private companies will not have to concern themselves with the stock exchange rules or proxy advisory firms, but there are unique challenges in the private company context. Boards of directors of private companies will need to consider what requirements there are, if any, contained in applicable governing documents, such as shareholder agreements, as well as valuation methods for determining if options are underwater and, if so, by how much (since share value cannot be determined by reference to the trading price on an exchange).

Canadian tax considerations

Unless done properly, a repricing which occurs by way of an option exchange could be considered a taxable disposition of the old option for Canadian income tax purposes for consideration equal to the value of the new option which may not be nominal based on valuation methods like Black-Scholes. Moreover, such a repricing could, in certain circumstances, deny the option holder the 50% deduction that might otherwise have been available in respect of the stock option benefit realized on the exercise of the old option.  It is therefore important to take appropriate steps to comply with the detailed rules in the Income Tax Act (Canada) regarding option exchanges.

The exercise price of the new option issued in exchange for the cancellation of the old option should not be less than the fair market value of the underlying share at the date of the exchange. The “in the money” value of the new option must not exceed the “in the money” value of the old option. Where those conditions are met, a special rule in the Income Tax Act (Canada) deems the old option not to have been disposed of and deems the new option to be the same options as, and a continuation of, the old option. Consequently, no tax is triggered on such an exchange and the ability to claim the 50% deduction is preserved (if it would otherwise have been available in respect of the old option). A company could also reprice an option by reducing its exercise price, without requiring an exchange of the old option for a new option (provided that the repricing could have been achieved through such an option exchange) with the same tax results. However, if other changes (in addition to reducing the exercise price) are made to the options (e.g., changing the vesting terms or extending the term), the amendments would generally need to be implemented through an option exchange.

The 2019 Federal Budget has proposed to limit the availability of the 50% employee stock option deduction for employees of “large, long-established, mature firms.” While those measures were to apply to grants of options taking place after 2019, the Minister has announced that the coming-into-force date has been postposed to a date to be announced in Budget 2020. The strategy regarding the repricing will have to take into account these new measures and their impact for the employees, but also to the employers.

Implications for U.S. taxpayers

In the United States, the repricing of an incentive stock option (ISO) is considered a modification akin to a new grant. The gain on exercise of a repriced ISO can only be treated as a capital gain if the shares are held for at least two years from the date of the repricing and more than one year from the date of exercise. In addition, only $100,000 of an employee’s options (based on the market value of the underlying share at the time of option grant) that become exercisable in a year may be treated as ISOs. If an option is repriced in a year that the option vests, a company must count both the original option and the new, repriced option in making this calculation. Prior consent of ISO holders should be obtained and the repricing offer should be open for less than 30 days.

For non-qualified stock options, any repricing must be done in a manner that complies with Section 409A of the United States Internal Revenue Code (the Code) so as not to trigger adverse tax consequences to the option holder. The repricing should be a single repricing and not indicating a pattern or practice, and the new exercise price must be at least the fair market value of the underlying share on the date of repricing.  The repriced option is treated as a new option under Section 409A of the Code.  No other material modification should be made that would tend to enhance the option benefit or provide for further tax deferral (for example, the expiry date of the option should not be extended). 

For a fuller discussion, read “Unintended Canadian and U.S. tax consequences of changing compensation arrangements during the COVID-19 crisis”

Other alternatives for rescuing underwater options

For companies that cannot or prefer not to undertake option repricing, consider the following alternatives:

Additional option grants

Companies may also consider awarding additional stock options to optionees (without cancelling outstanding options). If the exercise price of each additional option is at least equal to the market value of the underlying share at the time of the grant, the new option will provide its holder with a greater potential for gain than will existing options. However, this type of expanded stock option program will also exacerbate both dilution and overhang, and the company should be comfortable there is sufficient room in its share reserve.

Shareholders of a TSX- or TSX-V-listed company need not be asked to approve additional awards, unless an increase in the number of shares reserved for issuance under the existing option plan is required or the additional grants to insiders would cause the company to exceed the insider participation limits contained in the plan. However, if shareholder approval is needed, the company should be prepared for possible resistance from institutional investors. The proxy voting guidelines of the Ontario Municipal Employees Retirement System (OMERS), for example, indicate that OMERS may not support equity incentive plans that authorize shares to be issued under the plan that, in the aggregate, represent 10% or more of the company’s outstanding shares or plans that permit the granting or exercise of options in excess of 2% of outstanding shares annually (i.e., the burn rate[8] exceeds 2% on an annual basis).

In deciding whether to issue additional options to employees, companies should also take the following into account:

  • not only will new options be a charge to earnings, but because outstanding options will not be cancelled, accounting charges in respect of them will continue to be reflected on its books;
  • if the exercise price reflects a current market price for the underlying shares that is depressed because of general market conditions, optionees may receive a windfall if the share price rises as a result of the stabilization of the financial market and general economy, especially if the share price rises above the exercise price of the options that were underwater; and
  • the increased level of dilution and details respecting any awards made to named executive officers must appear in the company’s information circular for its annual shareholder meeting the following year.

Exchanging options for restricted stock or restricted share units

An alternative to stock option repricing involves cancelling existing stock options in return for grants of restricted share units (RSUs) or restricted stock with the same theoretical value as the cancelled options. Restricted stock is stock that is generally subject to a substantial risk of forfeiture at grant but that will vest upon the occurrence of certain time or performance-based conditions. RSUs are economically similar but involve a deferred delivery of stock or cash at a time that is concurrent with, or after, vesting. As discussed in further detail below, however, this alternative will have unfavourable tax consequences for the individual.

Since both restricted stock and RSUs (often referred to as “full-value awards”) ordinarily have no purchase or exercise price, fewer of them are required to grant a comparable award value than are needed in an option repricing. As a result, there is less dilution and lower equity overhang than in a repricing exchange of options.

While some companies may seek shareholder approval of their RSU exchange programs, the TSX only requires an issuer to obtain approval of a full-value award plan if treasury shares are reserved for issuance under it. Cash-only arrangements or those that are only funded by securities purchased in the secondary market do not require shareholder approval.

However, proxy advisory firms consider the substitution of other equity awards in exchange for options to be equivalent to a repricing of stock options.  Accordingly, it is preferable to consider awarding RSUs or restricted stock as additional incentives (without cancelling outstanding options).

If named executive officers benefit from them, full-value awards granted in any year are required to be described in the company’s information circular for its annual shareholder meeting in the following year, including details respecting the awards made to such officers in the year.

With respect to Canadian tax considerations, as a general rule, underwater stock options cannot be cancelled and exchanged for either restricted stock or RSUs without triggering a taxable benefit to the holder in an amount equal to the value of the restricted stock or RSUs. Accordingly, in such circumstances, companies should issue restricted stock or RSUs in addition to the existing, underwater stock options and not in exchange for the cancellation of the options. Moreover, because the value of restricted stock is taxable to the employee when the stock is issued (albeit subject to a possible discount to reflect the impact of the restrictions on the fair market value of the shares), RSUs are more commonly used in Canada.

RSUs which provide a holder with a right to receive a treasury share at a future date are taxed only when the RSU is actually settled for such shares (or surrendered at the holder’s instance for cash). However, where settlement may only be made in cash (or shares acquired on the secondary market or may be made in cash at the company’s option), the terms of the RSUs must require that they be settled within three years after the year of services to which the RSUs relate. Care should be taken not to exceed the relevant three-year period where RSUs are awarded in connection with underwater options that relate to services rendered more than three years prior to the award. Restricted stock and RSUs are generally not eligible for the 50% deduction referred to earlier.

In the United States, restricted stock is often a desirable replacement award because the share can be issued to the holder, but the value of the share is not included in income until it vests. However, the individual can choose to file an election to incur income taxation on the award date so that all gain after the award date (and after income inclusion) can be treated as capital gain. We note, however, that the ability to issue restricted stock is limited under most Canadian corporate statutes. The timing of settlement of RSUs must be structured to either be exempt from Section 409A of the Code as a short-term deferral or comply with one of the permissible payment events.

Other surrender programs

If share price is not expected to recover and equity overhang is a concern, offering employees the ability to surrender their options for cancellation in exchange for a cash payment is another alternative to consider if the company has the cash available to do so. For TSX listed issuers with a stock option plan with a fixed number limit, the share reserve will still be reduced by the surrendered options unless the plan has express language to the contrary that has been approved by shareholders. For publicly traded companies, both of these alternatives will likely require shareholder approval. Note that proxy advisory firms consider the substitution of other equity awards in exchange for cash to be equivalent to a repricing of stock options.

Extending option terms

Extending the original term of an option is one way to resuscitate in part the incentive impact of an option without increasing share dilution or concerns about pricing of awards. However, except for options that are about to expire, employees may not perceive much value in making the change.  And TSX and TSX-V listing rules and proxy advisory firm policies respecting stock option repricing also apply to proposals to extend the life of options.

Based on the Canada Revenue Agency’s most recent position, where the only amendment to a stock option plan or award is the extension of the expiry date, such an extension will not generally be deemed to create a new stock option agreement, nor will it generally create a disposition of the rights of the employee under the old stock option. As such, in and of itself, the extension of an option expiry date is generally neutral from a Canadian tax perspective.

In the United States, the extension of the term of an ISO will be treated as a modification akin to a new grant. The extension of the term of a non-qualified option at a time when the option is underwater is treated as a new option under Section 409A of the Code. See the discussion above under the heading, “Implications for U.S. taxpayers,” for tax implications of a new grant.


The COVID-19 pandemic and its severe consequences on stock prices will undoubtedly force companies to re-examine and potentially restructure their business strategies including the philosophy and assumptions underlying their compensation strategies. There is no universal solution.  Each company will have to decide on what course of action is in its best interest and the best approach — be it a repricing, additional grant, full-value award exchange or another solution altogether — will depend on many factors, including employee morale, business needs, shareholder base, investor views, plan reserves, burn rates and stock price history and projections. Therefore, if a company elects to develop an underwater option strategy, it should give careful consideration to which alternative is right for it prior to planning, developing and implementing the program.


[1] Geoff Zochodne, “The Toronto Stock Exchange just had its worst day since 1940. Yes, that’s 80 years”, Financial Post (12 March 2020), online: <>.

[2] Julius Melnitzer, “Option Repricing at Issue”, National Post (3 June 2009), online: <>.

[3] Colin Diamond and Henrik Patel, “Repricing Underwater Stock Options” in Selected Issues in Equity Compensation (National Center for Employee Ownership, 2019) 238, online: <>.

[4] For these purposes, insiders of an issuer are generally: (a) directors and senior officers of the issuer; (b) directors and senior officers of companies that are insiders or subsidiaries of the issuer; and (c) 10% (or greater) shareholders of the issuer.

[5] A foreign private issuer is an issuer that (a) is incorporated in a country other than the United States and has 50% or less of its voting securities held by U.S. residents; or (b) has more than 50% of its voting securities held by U.S. residents, but a majority of its executives are not U.S. citizens or residents, a majority of its assets are located outside of the United States and its business is principally administered outside of the United States.

[6] Glass Lewis, “Everything in Governance is Affected by the Coronavirus Pandemic. This is Glass Lewis’ Approach” (26 March 2020), online (blog): Glass Lewis <>.

[7] In general, the named executive officers are the Chief Executive Officer, the Chief Financial Officer and the three other highest‐paid executive officers of the issuer.

[8] Burn rate is a measure of dilution that indicates how rapidly a company is using its shares reserved for issuance under its stock option plan. Broadly speaking, the burn rate is the number of options created in a year relative to the number of outstanding underlying shares.