Benefits of Automatic Exercise Policy for Options

The answer to expired in-the-money options may be to implement “automatic exercise” just before options expire, according to a new NASPP blog post. Executive Director Barbara Baksa points out the ramifications of allowing options to expire as well as the pros and cons of auto-exercise at expiration.

• Expense. When vested options expire, there is no reversal of expense – the expense is fully recognized despite the fact that the executive did not receive any value, the opposite of “efficient” compensation. Additionally, the company will forfeit its tax deduction (which would have been realized when exercised).
  
  
• Litigation. Executives have turned to litigation when there is no way to recover the value of lost options – although the suit may not succeed it is costly and detrimental to morale to defend.

To avoid these outcomes, NASPP suggests implementing a process whereby options are auto-exercised on behalf of the executive on the last day that the option is exercisable, using a net exercise. The benefit of this is that a) it may reduce considerable administrative burden on the stock plan team of having to warn executives that an expiration date is approaching and b) it can be done without broker assistance and during a closed trading window, since it is not an open market sale.

The blog notes that in the case of incentive stock options (ISOs), such a strategy may be less desirable as it would disqualify them from preferential tax treatment. Plan language will also need to be updated for all options to include language regarding the auto-exercise, but overall the impact of such a change is fairly minimal given its potential to prevent unnecessary waste of option compensation.