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The Employee Ownership Update

Corey Rosen

September 6, 1998

(Corey Rosen)

Stock Option Repricing

With the recent fall in the stock market, the issue of stock option repricing has become a hot topic in many companies. Even in the bull markets of 1996 and 1997, as many as 33% of Silicon Valley companies repriced options, while 5% to 7% of public companies issuing options repriced them in 1997. A 1998 NCEO survey of broad-based stock option plan companies found that 36% had repriced in the last three years. Expectations are that many more companies will reprice in the current down market. In considering whether to reprice options, companies need to consider several factors.

First, companies should consider whether they should have the same policy for executives as for line employees. Executive options are explicitly awarded as incentives to help grow shareholder wealth. In fact, by law, companies paying executives over $1 million are limited in the tax deductions they can take for such pay unless it is performance related. If options are repriced every time stock goes down significantly, it is not clear that these options are really contingent on performance. By contrast, options for line employees are often granted as a compensation strategy -- people are getting options in lieu of pay. If this is the case, then option repricing may be more necessary.

Second, the impact of not repricing needs to be considered. Companies often argue that without repricing, valued people will leave. These assessments may be made rather glibly; given the amounts of shareholder wealth involved, it would make sense to assess these arguments with the assistance of outside compensation experts.

Third, companies should consider the potential impact of repricing on their income statement presentations. Proposed Financial Accounting Standards Board (FASB) rules would require that the difference between the old grant price and the new grant price of the option show up as a compensation cost. While this proposal is not expected to be implemented sooner than the year 2000, it is much more likely to be accepted by the Board than previous efforts to show the impact of options on financial statements was.

In structuring repricings, several approaches are possible. The simplest is to reset the price, usually to the current market price. Repricing could also take the form of extending the exercise period. Although technically not setting a new price, this approach effectively creates a new value for the options. A similar impact could be had by granting an additional set of options at the new lower price.

In any of these approaches, companies should consider what they and the shareholders get back in return for repricing. For instance, option holders might be asked to give back some of the shares they currently hold, restart vesting, face blackout periods when they cannot exercise the new options, or some combination of all three.

Practices of broad stock option plan companies concerning repricing and many other stock option plan design issues are discussed in detail in the NCEO's forthcoming publication Current Practices in Stock Option Plan Design ($50 to NCEO members; $75 to non-members). Expected out in mid-October, the roughly 200-page book (8 1/2 by 11 inches, spiral bound) will report and analyze responses to an unprecedented survey that asked well over 100 companies with broad-based option plans more than 150 vital questions on stock option plan design and administration. This Web site will announce the book's availability as soon as it is released.

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