Firms will, at times, replace employee holdings of out‐of‐the‐money stock options with new ones that have lower exercise prices. This paper seeks to examine how stockholders view such actions.
The stock price reaction to announcements of option exchange programs is used to establish how stockholders view option exchanges. Regression analysis is then used to get insight into firm and program characteristics that explain cross‐sectional differences in the stock price response.
A positive stock price response indicates that stockholders view such option exchanges as value enhancing. Regression analysis indicates that the price response increases with a firm's growth opportunities, the level of employee turnover, the extent to which employee option holdings are out‐of‐the‐money, and the quality of corporate governance. Deals where only non‐executive employees are allowed to participate are viewed more favourably.
This is the first paper to document that stockholders regard resetting the terms of employee option holdings in a positive vein, confirming implications emerging from theoretical papers on this subject. The paper also documents firm and program characteristics that impact the extent of possible value creation.
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