Options seen as next Nortel flashpoint
JOHN PARTRIDGE
Friday, March 16, 2001
High-tech giant Nortel Networks Corp. could be facing another investor and employee relations nightmare, this time over the extensive stock options program it uses to help attract and retain executives and other key staff.
Nortel chief executive officer John Roth alone made more than $135-million on stock options last year, when times were better.
However, as is the case with scores of other companies whose stocks have plunged in the carnage of the past few months, a large proportion of the options Nortel has awarded to its people are currently worthless. This means they are useless as an incentive, at least short term, and this could send key personnel heading for the exits.
But observers warn Nortel would likely encounter more wrath from already angry investors if it seeks to reprice the options lower -- difficult to do under U.S. accounting rules -- or issue new ones on more favourable terms.
The Brampton, Ont.-based company is already facing a thicket of class-action lawsuits over the stock price drop that ensued when it unexpectedly slashed previously optimistic growth forecasts on Feb. 15.
"It's a real conundrum," said John Koopman, a partner at executive recruiters Heidrick & Struggles Canada Inc. in Toronto. "If you're Nortel today, you've got to hold on to your key people."
However, shareholders small and large are turning negative on options, Mr. Koopman added, and the feeling is, "you win in the good times, so shouldn't you lose in the bad times?"
The annual report Nortel filed with securities regulators this week shows that about 70 per cent of the nearly 332 million options it had issued as of the end of last year are now under water.
The options' value is determined by the difference between the so-called exercise or strike price at which they are awarded and the market price of the company's shares when the employee becomes eligible to cash them in. The higher the stock price over the exercise price, the more the options are worth.
The Nortel report shows exercise prices for the underwater options range from $16.13 (U.S.) a share up to $90, with the weighted average coming in at $32.37. But since hitting a 52-week high last July of $89 on the New York Stock Exchange, the stock has plummeted. It closed on the NYSE yesterday at $15.90 a share, up 53 cents on the day.
Nortel refused to say yesterday whether it plans to adjust the option plan in some way, but it is far from alone in having to confront the issue.
"A lot of companies are struggling with it right now," said Edward Speidel, director of the executive compensation practice at PricewaterhouseCoopers Unifi Network in Boston.
A 1998 change in U.S. accounting rules has made simply repricing options almost prohibitively expensive from a tax standpoint, because they become a variable expense whose value must be marked to market throughout the options' term, which can be up to 10 years.
Instead, some companies, including Nortel competitor Lucent Technologies Inc. of Murray Hill, N.J., have issued several batches of additional options to employees at lower strike prices as their stocks have fallen. But this tactic is unpopular with investors because it dilutes the value of their shares.
Others, including long-distance telecommunications provider Sprint Corp. of Westwood, Kan., are taking advantage of a wrinkle in the post-1998 rules. It allows them to cancel underwater options, then issue new ones six months and one day later at what is then fair market value, without triggering the variable expense consequences.
However, The Wall Street Journal reported earlier this week that this tactic, too, can aggravate shareholders because it suggests a turnaround is not imminent.
Employees who opt for such a plan, an official of Institutional Shareholder Services of Rockville, Md., told the newspaper, are indicating that they "believe the stock price is going nowhere for the next six months."
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