The 'Repricing' of Executive Stock Options

Posted: 28 Jul 1997

See all articles by Don M. Chance

Don M. Chance

Louisiana State University, Baton Rouge - Department of Finance; Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration

Raman Kumar

Virginia Polytechnic Institute & State University - Pamplin College of Business

Rebecca B. Todd

affiliation not provided to SSRN

Date Written: March 1997

Abstract

We examine the incidence of corporations lowering the exercise prices of their executive stock options. These options can be viewed as a combination of a down-and-out call option and a down-and-in call option with the exercise price equal to the barrier. Using barrier option pricing theory, we find that at a minimum this features adds 7-10 percent to the value of the options on the grant date. We also examine the market, industry and firm-specific performance of a sample of 37 firms and 53 reset events. The period covered was 250 days before and after the day on which the firm reset the exercise prices of its executive stock options. The evidence strongly supports the conclusion that resetting the exercise price follows a period of poor firm-specific performance. The magnitude of the reduction in the exercise price was positively related to the firm's stock price performance and using a value- weighted market portfolio, it was negatively related to the market's performance. No evidence supports the contention that lowering the exercise price brings an end to the firm's problems and leads to an increase in shareholder wealth. Though the direct dollar impact at the time of the reset is relatively small to the shareholders, it is not insignificant to management. Allowing for the possibility of resetting after a stock price decline can create a perverse incentive under certain circumstances for managers to deliberately drive the stock price down further. In addition management has a greater incentive to engage in high risk projects than it would have with ordinary non- esettable options. These incentives and our results that the resets are indeed done, sometimes repeatedly, following poor firm-specific performance suggest that resetting is not in the best interests of shareholders, who should certainly question this practice.

JEL Classification: G13, G14, G32

Suggested Citation

Chance, Don M. and Kumar, Raman and Todd, Rebecca B., The 'Repricing' of Executive Stock Options (March 1997). Available at SSRN: https://ssrn.com/abstract=8439

Don M. Chance (Contact Author)

Louisiana State University, Baton Rouge - Department of Finance ( email )

2163 CEBA
Baton Rouge, LA 70803
United States

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration

Baton Rouge, LA 70803-6308
United States
225-578-0372 (Phone)
225-578-6366 (Fax)

HOME PAGE: http://www.bus.lsu.edu/academics/finance/faculty/dchance/

Raman Kumar

Virginia Polytechnic Institute & State University - Pamplin College of Business ( email )

Dept. of Finance, Pamplin 2126
Blacksburg, VA 24061
United States
540-231-5700 (Phone)
540-231-3155 (Fax)

Rebecca B. Todd

affiliation not provided to SSRN

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