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

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.