Is Repricing Stock Options Efficient?
February 28, 2001
Stock options have become the cornerstone of most management compensation packages. Under a typical plan, executives can buy a pre-specified number of company shares over a 10-year period at a given "exercise price." When stock prices fall, some boards of directors have "repriced" the exercise price to keep these stock options attractive and re-motivate the executives. A recent study analyzed 4,000 corporations between 1985 and 1994 to determine whether this "repricing" system is efficient.
The study finds that repricing is very infrequent and has very little impact:
- Only 37 of the 4,000 firms repriced their exercise prices -- for a total of 130 times.
- There was no significant market reaction in the 10 days surrounding the announcement of stock option repricing.
- On average, repricing lowers the exercise price by 40 percent and creates a gain of $150,000 to managers, representing 10 percent of total executive compensation.
The authors determined that companies reprice according to their company's relation to their industry and the economy as a whole. According to the study, repricing stock options is usually unnecessary as most stocks rebound to a profitable price within 19 months.
The authors find that repricing occurs when managers are entrenched within the corporation and have friendly board members. Also, small firms and firms having little cash flow that is otherwise uncommitted tend to reprice often.
Source: "Let Bygones Be Bygones," Economic Intuition, Fall 2000; based on Don M. Chance, Raman Kurnar, and Rebecca B. Todd, "The 'repricing' of executive stock options," Journal of Financial Economics, July 2000.
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