Option Repricing Research Articles

Option repricing, corporate governance, and the effect of shareholder empowerment

We use the practice of employee option repricing to investigate how shareholder involvement in firm compensation policies affects the quality of firm governance. We find that a 2003 reform that empowered shareholders to approve or reject repricing proposals led to value increases in previous repricers. The likelihood of repricing becomes less sensitive to poor manager performance, but remains similarly sensitive to bad luck, after the reform. Average post-repricing changes in firm performance are positive only after the reform. Overall, our results suggest that shareholder empowerment improves the governance of repricing and can transform repricing into a value-creating tool.

Option repricing and executive retention – revisited

PurposeThis paper aims to directly test the assertion by proponents of executive stock option repricing that repricing leads to increased management retention. Previous studies find either no effect or decreased retention following stock price repricing. This paper uses a more precise research design to re-examine the relationship between stock option retention and management retention.Design/methodology/approachThe authors use an empirical methodology and construct a sample of 158 firms and 201 repricing events, and a control sample of 201 non-repricing firms. They then examine executive turnover in the four years following the stock option repricing event.FindingsIt was found that, consistent with agency theory, stock option repricing actually results in greater executive retention. Specifically, CEO retention is significantly greater for repricing firms relative to non-repricing firms for up to three years following the repricing date, and non-CEO executive retention is significantly greater for two years.Research limitations/implicationsFirms continue to restructure management through stock option repricing. However, recent option repricing has been undertaken during a period when the economy is in decline, making it is difficult to disentangle effects of option repricing on management retention. Hence, this paper uses repricing data from an earlier period, from 1992-1997, when the economy was good.Originality/valueMany firms argue that when stock options are out-of-the-money and managerial talent is in demand, repricing executive stock options is necessary to retain managers. Previous studies find contradictory or no support for this view. Using a much more precise methodology, this paper shows that firms do retain managers when they reprice their options compared to when they do not.

Option Repricing, Corporate Governance, and the Effect of Shareholder Empowerment

We use the practice of employee option repricing to investigate how shareholder involvement in firm compensation policies affects the quality of firm governance. We find that a 2003 reform that empowered shareholders to approve or reject repricing proposals led to value increases in previous repricers. The likelihood of repricing becomes less sensitive to poor manager performance, but remains similarly sensitive to bad luck, after the reform. Average post-repricing changes in firm performance are positive only after the reform. Overall, our results suggest that shareholder empowerment improves the governance of repricing and can transform repricing into a value-creating tool.

Options, option repricing in managerial compensation: Their effects on corporate investment risk

While stock options are commonly used in managerial compensation to provide desirable incentives, they can create adverse incentives to distort the choice of investment risk. Relative to the risk level that maximizes firm value, call options in a compensation contract can induce too much or too little corporate risk-taking, depending on managerial risk aversion and the underlying investment technology. We show that inclusion of lookback call options in compensation packages has desirable countervailing effects on managerial choice of corporate risk policies and can induce risk policies that increase shareholder wealth. We argue that lookback call options are analogous to the observed practice of option repricing.

Motivating innovation with a structured incentives scheme Extending the Manso model

The conventional pay-for-performance schemes are designed for inspirit agents to exert effort. Manso structured incentive schemes to motivate innovation in a two-period production process. However, his solution is just dependent on the probability of success of different actions (work methods), and not on the amount of performance of these actions. In combining these two methods, this paper proposes a model and gives the optimal incentive contracts. By providing the suitable incentive contract to the agent, the principal can motivate the agent to be more innovative but to be more exerting effort to obtain more output. In the context of managerial compensation, an optimal innovation-motivating incentive scheme can be implemented via a combination of stock options with long vesting periods, option re-pricing, golden parachutes and managerial entrenchment. Key words: Motivating innovation, structured incentive, path dependent, exploitation and exploration.

Proxy advisory firms and stock option repricing

This paper examines the economic consequences associated with the board of director’s choice of whether to adhere to proxy advisory firm policies in the design of stock option repricing programs. Proxy advisors provide research and voting recommendations to institutional investors on issues subject to a shareholder vote. Since many institutional investors follow the recommendations of proxy advisors in their voting, proxy advisor policies are an important consideration for corporate boards in the development of programs that require shareholder approval such as stock option repricing programs. Using a comprehensive sample of stock option repricings announced between 2004 and 2009, we find that repricing firms following the restrictive policies of proxy advisors exhibit statistically lower market reactions to the repricing, lower operating performance, and higher employee turnover. These results are consistent with the conclusion that proxy advisory firm recommendations regarding stock option repricings are not value increasing for shareholders.

Option repricing, management turnover and restatement

This study examines the association between financial restatements and executive option repricings and tests whether stock option repricing reduces management turnover in restating firms. We found a positive association between financial restatement and management turnover and those financial restating firms are likely to implement option repricing when the manager’s equity compensation is large and the sensitivity of the option value is high. However, we found no evidence that executive option repricing reduces management turnover in financial restating firms. Our analysis showed that, although financial restating firms may implement option repricing to restore the option incentive effect, valuable managers often leave their jobs because of poor future prospects in restating firms. Our results, therefore, suggest that repricing of executive stock options is not an effective management retention strategy for financial restating firms but managers’ equity compensation and option value incentives are important determinants of option repricing.

Corporate Governance: Incentive Pay with 'Rolling Option Repricing' Terms: The Role of Advisory Services (ISS, Glass Lewis); Ramtron Case Study

This brief essay looks at corporate governance issues that may arise when a company’s incentive pay package permits “rolling option repricing”.In the case of Ramtron International Corporation (RMTR), the company proposed for shareholder vote at its annual meeting a pay package (the “2012 Plan”) authorizing the issuance of options and other equity incentives amounting to 9.9% of the firm’s outstanding shares. Because Ramtron’s 2012 Plan provided that any outstanding award under prior plans that subsequently expired or was forfeited would be rolled back into the 2012 Plan authorization, a vote in favor of the Ramtron 2012 Plan actually became a vote to authorize the potential issuance of equity awards amounting to 26.6% of outstanding shares. Leading advisories Institutional Shareholder Services (ISS) and Glass, Lewis & Co. LLC recommended a vote in favor of Ramtron’s 2012 incentive plan. Is an incentive pay plan that potentially authorizes option grants to management amounting to 26.6% of currently outstanding shares an unreasonable size (too expensive)? How does enabling the rollover and reissue of expiring/forfeited options at lower prices with extended maturities differ in end result from enabling option repricing (a practice cited by advisories as a cause for disapproval of a plan)? What can be said about the criteria and operation of institutional shareholder advisory services? Corporate officers and directors, in proposing pay incentive plans, may want to give these issues thought, and, regardless of the recommendations of advisory services, investors may wish to more closely inspect proposed plans that include “rolling option repricing” terms.

Motivating Innovation

ABSTRACTMotivating innovation is important in many incentive problems. This paper shows that the optimal innovation‐motivating incentive scheme exhibits substantial tolerance (or even reward) for early failure and reward for long‐term success. Moreover, commitment to a long‐term compensation plan, job security, and timely feedback on performance are essential to motivate innovation. In the context of managerial compensation, the optimal innovation‐motivating incentive scheme can be implemented via a combination of stock options with long vesting periods, option repricing, golden parachutes, and managerial entrenchment.

The Silver Lining of Managerial Opportunism

From the beginning of the 1990s until the start of the twenty-first century, managers employed a variety of notorious practices, which were gradually exposed and denounced. Option-dating games, manipulation of financial disclosures, option repricing, IPO spinning, and huge portions of concealed pay are some of the prominent examples. This paper argues that these practices, albeit deplorable, had an important beneficial aspect to them. In fact, they served to counteract the culture of option-based compensation and other risk-inducing pay schemes that was on the rise at the same time. These practices enabled executives to enrich themselves without the need for raising corporate risk-taking to extreme levels. While corporations were mounting options and short-term bonuses, the adaptive responses dulled the edge of their risk- inducing potential. That is to say, one, unnoticed effect of these troubling practices was to repress the risk-taking that incentive compensation would have otherwise produced. However, at the beginning of the twenty-first century, a combination of new regulation, stock-exchange listing requirements and intensified market attention inhibited most of the risk-mitigating practices. An amendment to the federal securities regulation made option backdating almost impossible ; the accounting profession underwent a major overhaul, leaving less leeway for management to manipulate favorable disclosures; and stock exchanges’ listing requirements made option repricing unfeasible. This was also the fate of many other practices that enabled managers to conceal substantial portions of non-incentive based benefits, such as stealth compensation and IPO spinning. This new market reality set the stage for what became all but the only way for managers to make a lot of money through their compensation packages: by adding risk. The market apparently tried to adapt to the new reality by gradually reducing the use of stock options. However, certain industries, primarily the financial industry, are able to increase their risk profile rather rapidly. And with the heightened incentive to add on risk, it is small wonder that the financial industry brought the economy to a boiling point.

Do ISS Voting Recommendations Create Shareholder Value?

Many institutional investors rely on a proxy advisory firm to assist them in voting the company proxy and fulfilling their fiduciary responsibility to vote in the interest of beneficial shareholders. The largest and most influential proxy advisory firm is Institutional Shareholder Services (ISS). The recommendations of ISS are not inconsequential. Academic and professional research suggests that a recommendation by ISS can change the outcome of a vote by 15 to 20 percent, depending on the matter of the proposal.At the same time, there is little evidence that proxy advisory recommendations are correct or that they improve corporate outcomes. In fact recent research suggests that they might actually decrease shareholder value.We examine these issues as they relate to ISS guidelines for exchange offers and option repricings: Do proxy advisors have appropriate incentive to verify that their recommendations are correct?Should board members require evidence that ISS guidelines are value increasing before they adjust their policies to gain a favorable recommendation?Proxy advisory firms enjoy significant barriers to entry and little competition. Is this desirable for shareholders?Related Research Paper on SSRN: The Role of Proxy Advisory Firms in Stock Option Exchanges; Authors: David F. Larcker , Allan L. McCall and Gaizka Ormazabal , Stanford Graduate School of Business: http://ssrn.com/abstract=1811130.Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the book Corporate Governance Matters, and A Real Look at Real World Corporate Governance.

Alternatives to Traditional Repricing of Executive Stock Options

The main purpose of this paper is to examine two commonly used alternatives to traditional repricing (TR) of executive stock options (ESOs) in a dynamic agency model. TR practices have become obsolete since new accounting rules took effect in July 2000. To avoid associated variable accounting charges that cause uncertainty in future reported earnings, companies have tried several TR alternatives as solutions to rescuing underwater options. We justify the occurrence of TR alternatives and quantify the impact of the marking-to-market feature imbedded in the new accounting rules. We also propose an incentive measure which is comparable to the subjective value of ESOs claimed by Ingersoll, J (2006) to rank TR alternatives in terms of agent's incentive.

Repricing of executive stock options

The main purpose of this paper is to extend the model of Acharya et al. (J Financ Econ 57:65–101, 2000) to examine the ex-ante optimality of repricing of executive stock options while considering dilution effects and the tax effects of new accounting rules associated with repricing. Although there has been a body of empirical literature on repricing, the optimality of repricing after considering the economic impact of changing accounting rules has not been addressed in an ex-ante contracting setting. We find that traditional repricing loses its ex-ante dominance over the do-nothing strategy after we incorporate the tax effects of new accounting rules. The theoretical predictions of our paper shed light on this controversial practice and lay a foundation for evaluating repricing alternatives.

Employee stock options and future firm performance: Evidence from option repricings

We investigate firms’ operating performance subsequent to the repricing of executive and non-executive employee stock options. We find that, relative to non-repricers, repricing firms have a larger increase in operating income and cash flows in subsequent periods. This performance improvement is attributable to the underlying economic determinants of the decision to restore the options’ incentive properties. However, only repricings of executive stock options are associated with improvement in performance; we find no such evidence for non-executive employees. Our findings suggest employee stock options provide sufficiently large incentive effects to favorably affect firms’ performance, but primarily so at the executive level.

Stock Option Repricing and Its Alternatives: An Empirical Examination

AbstractIn this paper I examine the likelihood of CEO stock option repricing and its alternatives: namely, option grant, stock grant, and “do nothing.” Multinomial logit results suggest that firms reprice options to increase sensitivity of pay to stock price and to temper down sensitivity of pay to volatility. Moreover, repricing firms are younger and more concentrated in industries where human capital is important. Finally, I find no evidence that internal governance or executive conflicts of interest are relevant in explaining repricing. My results indicate that repricing is motivated by incentive alignment and retention, and not by agency cost considerations.

The incentive effect of repricing in employee stock options

Purpose – This paper seeks to evaluate the cost of repriceable options, and to investigate whether repriceable employee stock options (ESOs) cost more than standard ESOs in providing incentives to employees.Design/methodology/approach – This paper develops an intensity‐based model, reflecting the special features of repriceable ESOs. The model is used to assess shareholder cost of repriceable ESOs, to explore their early exercise pattern and to compare their incentive effect with standard ESOs.Findings – Two main conclusions arise. First, option holders of repriceable ESOs postpone their exercise before repricing. But, once the exercise price has been reset, option holders are more likely to exercise ESOs early. Second, option repricing is less cost‐effective than standard options in providing incentives.Practical implications – This research finds that issuing new options proves more efficient than option repricing in providing incentives. In turn, this research offers a practical guideline to companies ...

Stock Option Repricing and its Alternatives: an Empirical Examination

Studies on determinants of stock option repricing contrast repricers with firms that do not conduct repricings. In practice, firms resort to other alternatives to retain managers and to restore incentives. We examine a broad array of alternatives that includes repricings, stock option grants, restricted stock grants, and the neutral alternative of doing nothing. Multinomial logit results suggest that firms reprice CEO stock options in response to economic factors. We address the debate on whether agency conflicts between managers and shareholders are severe in repricing firms, and do not find evidence that repricers are characterized by weak boards or entrenched managers.

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

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.

Stock Option Repricing in Europe

This paper investigates the link between option repricing, firm performance and corporate governance in Europe. Our sample consists of 77 European firms that repriced their stock option between 1987 and 2003. We document that option repricing is mainly a phenomenon for young and fast growing firms that showed a sharp decline in accounting and stock price performance in the two years prior to the repricing. On the day of the repricing, the exercise prices of the outstanding options are on average 60% above the share prices. This underwater problem is corrected through the repricing. In 20% of all sample firms the associated change in the Black Scholes-value exceeds 10% of the firms' market capitalization. The repricing implies an average increase in the annual salary of an executive of about 40%. Cash salaries are not adjusted downwards when options are repriced. The performance of the repricing firms improves significantly after the repricing. We provide evidence that suggest that the favorableness of the repricing structures is related to corporate governance structures.

Stock Price Reactions to the Repricing of Employee Stock Options*

AbstractWe study whether the repricing of employee stock options is in the best interests of common shareholders by examining the excess stock returns associated with timely, noncontamin‐ated repricing announcements made by Canadian firms. On the basis of three theories of why firms reprice, we develop competing predictions about the mean announcement‐date excess stock return and the cross‐sectional relations among excess stock returns, the estimated probability of repricing, and proxies for predictions from each theory. For a sample of 72 noncontaminated repricing announcements made by Canadian firms between November 1994 and July 2001, we find a reliably positive three‐day announcement‐date mean excess return of 4.9 percent. The results of our cross‐sectional analyses suggest that the market responds favorably to repricings because they assist in retaining key employees even though, at the margin, they enable managers to extract rents from shareholders. We do not find sufficient statistically significant evidence to reliably conclude that repricings are done to realign employee incentives.