Executive Stock Option Repricing: The Cost to Firms and Value to Executives

Abstract

Employee stock options go underwater when stock prices decline. In the 1990s, firms responded by repricing underwater options, a practice in which underwater options are replaced by new at-the-money options. We examine the repricing of options from the perspective of the costs of repricing to firms and the value to employees. Using a hand-collected dataset, we find that the primary recipients of option repricings are lower ranked non-executive employees rather than executive officers. The costs of repricings to firms is rather modest relative to its value to risk-averse, undiversified employees. We also find that repricing results in a large change in the level of incentives, i.e. pay-performance sensitivity, from the perspective of the employees. The asymmetry between the lower costs to firms and the greater value to employees perhaps explains why repricing, and similar alternatives that deal with underwater options, remain popular even in the face of criticism from institutional investors.