The incentive effect of repricing in employee stock options

Abstract

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 confronted with underwater options.

Originality/value

Constructing and applying a more accurate valuation model than those previously developed, this paper investigates several important questions about ESOs repricing. Chiefly, this research helps academics and practitioners better understand the cost of repriceable options, how repricing influences employees’ early exercise decisions, and whether option repricing is cost‐effective in providing incentives. These are important questions to ask, filling gaps in the existing literature.

Citation

Wendy Wu, Y. (2009), "The incentive effect of repricing in employee stock options", Review of Accounting and Finance, Vol. 8 No. 1, pp. 38-53. https://doi.org/10.1108/14757700910934229