Skip to main content
Opens in a new tab External site

October 2022 / 10 Min Read

Addressing Employee Equity Alternatives in a Bear Market


Companies are struggling to retain employees. In the U.S. and the UK in particular, one factor is the falling value of employees’ unvested equity.


Key Takeaways

  1. Employees’ unvested equity compensation has fallen along with the slumping stock market.
  2. Companies have several approaches they can consider when thinking about whether to address the fall in unvested equity compensation.
  3. In determine whether to act – and which approach to take – companies should consider local governance best practices and their own unique situations.

Companies continue to be challenged with retaining their key employees. Employee turnover remains high at a median 15.4 percent across industries globally, according to Aon’s Salary Increase and Turnover Study from September 2022. Meanwhile, transparency in pay, a change in expectations of the employee experience and high inflation have contributed to an environment where companies are looking for creative ways to employ their compensation strategically and cost efficiently.

In the United States (U.S.) and the United Kingdom (UK) in particular, one factor contributing to retaining key employees has been the value of unvested equity, as these regions use equity compensation more widely than other parts of the world. Over the last decade the bull market has proven that equity and the upside leverage that it provides to equity grant recipients provides real wealth-creation opportunities to those fortunate enough to hold these grants. The decline in the markets in 2022 has abruptly reversed that course. The FTSE 350 fell 5 percent and the S&P 500 was down 16 percent for the first eight months of the year and continue to decline. High-growth sectors like technology and life sciences, whose valuations are based on expected profits in the distant future, are seeing some of the largest declines.

This new bear market has vastly reduced the value of employees’ stock grants at most companies, especially for grants made within the past year. Many companies are examining alternatives to boost the retention values of outstanding equity as one component of an overall retention strategy for key employees. While impacting all industries, the greatest impact is on heavy users of market-priced stock options such as life sciences, technology and private equity-owned companies that find themselves with a huge amount of equity overhang with little to no paper value and, therefore, little to no retentive value.

These companies recognize that with a falling stock market, employees can benefit by walking away from low value/underwater grants and going to a competitor to receive new grants that are denominated at the current lower share values. In other words, employees are incentivized to job hop for more shares with higher upside potential.

In this article we identify the alternatives available to companies with underwater equity and the criteria for selecting the most viable route for a company to choose.

Alternatives to Underwater Equity

Option 1: Do nothing

The first step of any employer concerned about the declining value of employees’ equity is to evaluate how much of a problem this underwater equity presents to your company. An analysis for key groups of employees should be conducted and analyzed to gauge the issues at hand, measuring current turnover rates, the potential cost of increased turnover, and the amount of unvested equity value. Separate executives, especially named executive officers, from the rest of employees as there are special governance considerations for this group.

The first of the alternatives is to simply wait and not take any action. This approach will make the most sense at a company:

  • that is not materially impacted by large amounts of turnover,

  • isn’t concerned if turnover increases because the cost of talent acquisition is low or the supply of talent is still considerably high, or

  • the value of unvested equity is either still high enough for key talent or the company believes that their share price will rebound quickly enough that this is a non-issue.

In the UK market and many other regions in Europe, the “do nothing” approach is often the most palatable to shareholders and their advisors. Since equity is not awarded as far down the organization, the declining value of executives’ equity grants presents less of a retention concern. The culture is focused on senior leaders sharing the same outcome as shareholders when it comes to financial returns.

Similarly, the rationale for not acting in the U.S. is that volatility is a part of life when it comes to equity compensation. Additionally, there is likely still considerable time left on the underwater options for the grants to come back “in-the-money,” and some participants caution against companies overreacting if volatility is short lived.

Option 2: Take action with four main alternatives

If a company concludes that they must take action now — which is the case for many companies at present — then the alternatives available have a range of impact on retention, cost and expected shareholder reaction. The alternatives in terms of lower to higher impact include:

  1. Pulling forward future grants

  2. Making an additional grant in the form of options, performance share units (PSUs) or restricted stock units (RSUs) or cash if there are not sufficient shares available

  3. Option exchange/repricings for companies that heavily use stock options (note: this is not common in the UK since stock options are less prevalent and this approach is not supported by corporate governance best practices in the region)

Within these alternatives there are two additional factors impacting both cost and governance:

  • Award size: The larger the award, the greater the retention value and the greater the cost in terms of expense, share usage and potential shareholder push back.

  • Inclusion or exclusion of executives: Including executives will have a large impact on the costs of taking action and opens the door to scrutiny from shareholders and their proxy advisors.

Option 3: Exclude executives

A third option would be more acceptable to certain shareholder groups. Provide named executive officers with either a shareholder friendly grant, such as performance shares, or do nothing while taking care of the remaining key employees. Executive compensation is already under high scrutiny and repricing or granting additional shares to named executives must be disclosed in the annual proxy statement — potentially further raising the ire of shareholders, particularly in the UK.

Option 4: Look ahead to future grants

A final option we outline is accepting that current grants are declining in value but rather than address that retroactively, corporate boards can look ahead to future grants and mitigate concerns if they believe market volatility will continue to be driven by exogenous factors that should not necessarily drive all long-term incentive outcomes.

Firms with performance-based equity awards that vest on share price performance could consider migrating to a relative total shareholder return (TSR)-based plan rather than rely on absolute share price or market cap hurdles. Event companies with absolute TSR could consider amending caps or restrictions on payouts if relative performance is strong. (See our article “Why Discretion in Equity Plan Awards Matters to Boards and the C-Suite” for more information about using discretion in payouts.)

And for companies issuing stock options, adjusting the future mix to incorporate a balance of options and full-value shares, such as RSUs, could signal to employees that the company understands their negative experience around equity and is taking steps to ensure some level of payout under future awards.

In the UK market and many other regions in Europe, the “do nothing” approach is often the most palatable to shareholders and their advisors. Since equity is not awarded as far down the organization, the declining value of executives’ equity grants presents less of a retention concern.

Exploring the Pros and Cons of Different Approaches

Pulling Forward Future Grants

When discussing the alternatives at hand, a lot of the decision-making rests on timing — how quickly can the company remedy the situation. Often, underwater equity presents with a rapidly depleting share pool due to the depressed stock price, making some alternatives less attractive than others or even impossible to execute in a meaningful way. Pulling forward future grants is a way for companies to retain employees by denominating the grants and fixing a new lower exercise price to the grants to articulate value, ideally without overextending the share pool reserves. In theory, the company provides no additional cost and minimal shareholder dilution using this alternative. For UK-listed companies, any accelerated grants should be checked against the Investment Associations’ 10-year rolling period dilution caps and annual executive director policy limits.

Part of this pull-forward might also include a discussion of changing the mix of the traditional annual grant, whereby the weighting on options could decrease and the weighting on RSUs could increase. This would typically be considered to provide downside protection that options do not intrinsically have and would prevent the company from facing a similar situation if the pulled forward option grant ends up underwater and thereby loses retentive value.

The downside of this approach is the reporting ramifications and the potential for a lower or non-existent annual grant the following year, depending on how aggressive the company gets with pulling forward the grants. From a reporting standpoint, this could result in two annual grant values being presented in the present year’s Summary Compensation Table in the annual proxy statement, which would need significant narrative to explain the rationale to shareholders and may result in a negative shareholder say-on-pay vote.

With this approach there is also the potential perception of “spring loading” (i.e., timing grants at a historically low share price). Proxy advisory firms ISS and Glass Lewis may take this practice as a reason to recommend voting against the company’s say-on-pay vote and possibly even a future share request. Spring loading is a greater concern with options because the value will be grants.

Making an Additional Grant

Granting additional equity can be a more effective way of using equity compensation to retain employees without causing the double-disclosure issue that pulling forward future grants presents. It also eliminates confusion among employees when the annual grant cycle rolls around and they didn’t understand their annual award was already granted the previous year. However, companies must first determine if they can afford from their share pools to make grants in addition to their next planned annual grant.

The key decisions surrounding making an additional grant include:

  • Whether to make the grant in options since there is a potential that these options could end up underwater depending on how long the bear market lasts, where the company is in the market and other macro- and microeconomic factors.

  • Whether to switch the entirety of the grant or part of the grant to full-value shares like RSUs that would still vest over time but have downside protection in an uncertain market.

  • And whether to include a performance condition on the RSU such that it becomes a PSU and requires something more than years of service at the employer to vest the award.

A company should consider how each alternative would impact their burn rate, dilution, remaining share pool and employee retention before deciding which vehicle to grant. Particularly with the PSUs, the company should be ready to set long-term goals, articulate goals, and track and measure them to ensure the performance conditions incentivize the right behavior and strike a balance in being achievable but challenging.

An Option Exchange or Repricing

Companies with share pool constraints can consider an underwater stock option exchange (UWSE) or one-for-one unilateral repricing. This approach is controversial from a governance standpoint, but it is also efficient in addressing outstanding underwater equity and bringing immediate value back to employees’ shares. For public firms in the UK and Europe, a repricing under any structure will not be supported by investors. Private firms, however, may have greater flexibility to reprice awards if the major private equity investors are supportive.

A UWSE allows employees that hold underwater options to trade them for an at-the-money (or less underwater) stock option that often has reset vesting conditions that require employee service, thereby attempting to guarantee retention of the employee once the trade is complete.

The balancing act of injecting value back into the existing options and retaining and motivating performance to benefit the shareholders and company is done via:

  • Setting the exchange ratios to be value-neutral whereby the aggregate fair value of the underwater equity is equivalent to the aggregate fair value of the at-the-money grants

  • Resetting vesting to a minimum of one year in order to require continued service and performance

  • Reducing overhang by returning options to the company

  • Determining eligibility to participate (both for employees and for option grants) in the most shareholder-friendly manner

Most equity plans require shareholder approval to enact a UWSE. The makeup of a company’s investors will influence whether such a program is attainable. Additionally, there are resources and cash needed to conduct shareholder outreach, drafting the filing, related administration and more.

Some companies express interest in a unilateral repricing with no exchange or extension of vesting terms. This involves reducing the exercise price in order to “reprice” the options to no less than the current fair market value of the stock. This approach is a pure windfall to the employee and includes none of the balancing act that a UWSE has to benefit the company and shareholders. It is significantly more costly from a non-cash expense but has no cash costs outside of normal administration of the plan. The issue here exists with shareholder approval because not many investors are amenable to such a program.

In instances where a company’s plan does not require shareholder approval for either a UWSE or a repricing, companies should consider the long-term ramifications of not getting shareholder approval. This can include ISS and Glass Lewis recommending against the say-on-pay resolution and/or the compensation committee members or against any new equity plan proposals (i.e., an entirely new plan or share increase to a current equity plan).

Don’t Ignore Governance Issues

While we have touched on shareholder and shareholder advisor concerns, there are potentially other challenges that fall into two distinct categories: say-on-pay risk and share pool renewal risk.

Investor advisors and some investors prefer that named executives do not receive special grants for retention. This is, importantly, not an absolute prohibition on making a grant to senior officers. Companies must consider the risk of losing a key leader against the possibility of a negative say-on-pay vote. The actions that can be taken to mitigate the risk include:

  • Moderating the size of the grant to executives

  • Adding meaningful performance conditions to the vesting of the grant

  • Communicating directly with shareholders regarding the reasons for making a grant to executives

  • Excluding the CEO

The share renewal risk is most associated with companies doing a UWSE. Remember first that it is likely your company will need shareholder approval in the first place. Second, shareholders expect this to be a one-time event. Companies doing this more than once may face shareholder push-back when it is time to obtain approval of a new pool.

Some investors and their advisors prefer that named executives do not receive special grants for retention. This is not an absolute prohibition, but companies must consider the risk of losing a key leader against the possibility of negative shareholder reactions such as a failed say-on-pay vote.

Next Steps

While there is no one-size-fits-all approach to any industry, company or group of employees, there are many approaches to help companies fight the retention risks that accompany a bear market. Understanding the impact to employees, the firm’s compensation philosophy and the governance policies of investors will help companies formulate a plan to weather stock market volatility and retain and motivate employees appropriately while mitigating shareholder concerns.

If you’d like more information about how Aon can help your company address employee equity in a volatile and bear stock market, please write to

General Disclaimer
The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

Terms of Use
The contents herein may not be reproduced, reused, reprinted or redistributed without the expressed written consent of Aon, unless otherwise authorized by Aon. To use information contained herein, please write to our team.