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Academic Research: The incentive effect of repricing in employee stock options - 2010

The incentive effect of repricing in employee stock options

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Document Information:
Title: The incentive effect of repricing in employee stock options
Author(s): Yan Wendy Wu, (School of Business and Economics, Wilfrid Laurier University, Waterloo, Canada)
Citation: Yan Wendy Wu, (2009) "The incentive effect of repricing in employee stock options", Review of Accounting and Finance, Vol. 8 Iss: 1, pp.38 - 53
Keywords: Compensation, Employees, Incentive schemes, Stock options
Article type: Research paper
DOI: 10.1108/14757700910934229 (Permanent URL)
Publisher: Emerald Group Publishing Limited
Acknowledgements: The author appreciates the remarks and suggestions offered by Robert Jones, Melanie Cao and two anonymous referees. The author also thanks the participants at University of Waterloo seminar and 2007 Southwestern Finance Association for their helpful comments and suggestions. All errors are those of the author.
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.

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