Altering the Terms of Executive Stock Options
New York University, Center for Law and Business, Working Paper No. 98-001
32 Pages Posted: 30 Aug 1998
Date Written: October 1998
This paper examines the practice of resetting of the terms of previously-issued executive stock options. We identify the properties of the typical reset option, characterize the firms that have reset options, and develop a model to value options that may be reset. In our sample of 396 executives whose options had terms reset in the 1992-95 period, a large majority ad exercise prices reset to the market price. This resulted in a reduction of the typical option's exercise price by about 40%. Slightly less than half of these options also had their maturities extended, generally receiving a new expiration of 10 years.
We find that resetting has a strong negative relationship with firm performance even after correcting for industry performance. Resetting is also significantly more common among small firms than among large firms. However, few other industry- or firm-specific factors appear to matter. Finally, we find that the possibility of resetting does not have a large impact on the ex-ante value of an option award, but the ex-post gain can be substantial.
JEL Classification: G12, G39
Suggested Citation: Suggested Citation