For many years, a top priority of Hewlett-Packard Co.'s share repurchase program has been to offset dilution from employee share programs. By mid-2005, HP had gone five years without significant dilution from employee stock option exercises. Then in 2005, HP's shares began to rise, unleashing a flood of employee stock option exercises.

HP's treasury had forecast the consequences of rising shares and had developed a tool to predict how many would be exercised at different prices. If the stock kept rising, "the number of shares [HP] would need to buy back to offset dilution would be much higher," says Kenneth J. Frier, vice president of corporate treasury.

Treasury proposed that HP come up with a way to offset future dilution. HP needed to: 1) set a price cap per share to buy back stock; 2) structure the transaction so that it would have an impact on shares outstanding over time rather than all up-front; 3) have efficient pricing; and 4) offer downside protection.

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