Crisis sends options ‘underwater’

SHARE options are a common part of high-level remuneration packages intended to be powerful incentives for company executives – but they can quickly go ‘underwater’ when markets tumble.

Executives or indeed any employee holding underwater options would be better off buying shares on the open market.

While executives at big companies often have options in their remuneration packages, they also tend to have attractive base salaries.

By comparison, executives at startups – or smaller companies still establishing themselves – with limited cash supplies usually take a bigger slice of their salary in options.

Western Australian gold exploration company Apex Minerals provides a good insight into the structure of small listed companies.

Production woes at its flagship Wiluna mine have sent its share price tumbling to 4.2 cents, while option packages are due to expire in 2011 with exercise prices of 10 times that amount.

Up to 70 per cent of the pay packets of the company hierarchy, which includes Mark Ashley, Mark Bennett, Glenn Jardine and Kim Robinson, are made up of options.

Unless the company makes a significant turnaround the underwater options will become worthless.

Messrs Ashley, Bennett and Jardine also each takes home more than $400,000 in base salary, director fees and bonuses, not including options.

Executives at small companies are more likely to forgo cash rewards to support the company during a tough time, especially when the executive has a large chunk of company stock that he or she hopes will increase in value. Often, they take options in lieu of a cash bonus.

The sheer number of underwater options has led to a debate on whether those options need to be re-priced, or whether new options should be issued taking into account current economic conditions. In short, unrealised rewards can still be realised with the rejigging of a contract.

Steven Cole, WA president of the Australian Institute of Company Directors, says company boards are under pressure to restructure remuneration packages when share price movements substantially cut an executive’s pay.

“When the executive no longer sees that return ... they figure they need to get fair value for their performance,” Mr Cole says.

“I think there’s going to be some pressure for recognition.”

The AICD is concerned legislative changes could lead to very prescriptive rules around executive pay when it argues that the negotiation process needs to be flexible.

“A lot of the time you are negotiating with the executive’s spouse, who knows what equivalent executives are being paid elsewhere,” Mr Cole says.

“I think people underestimate the personal nature of that. You can’t explain that to 20,000 shareholders.”

There are some executives of big companies who stand out as having a large percentage of their salary tied up in options, such as Paladin Energy founder John Borshoff ($3.8 million in options out of a total salary of $5.7 million) and Wesfarmers’ head Richard Goyder ($3.6 million out of $8.1 million).

Fortescue Metals Group founder Andrew Forrest takes a minimal salary (less than $200,000) at the iron ore company, and an all-scrip director payment from Poseidon Nickel; which he donated to his charity earlier this year.

Another interesting remuneration package is that of Len Jubber at Bannerman Resources. In fiscal 2009, 90 per cent of Mr Jubber’s $2.3 million salary at the uranium explorer consisted of options.

Stock in Bannerman is currently trading at around the $1.20 mark, representing a tripling in its share price during the past 12 months.

But because Bannerman was at one-time worth more than $4 a share, employees have options with exercise prices of anywhere from 20 cents to $7.50 depending on when the packages were negotiated.