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Repricing and option exchange programs have long been a controversial practice. A study released earlier this year looks at whether repricings boost company performance.
The Repricing ControversyIn the NASPP's 2010 Stock Plan Design Survey, although 61% of respondents indicated that more than 50% of their options had been underwater in the past two years, only 7% had repriced (another 4% exchanged underwater options for full value awards, cash, or a combination of stock and options). Critics argue that repricing underwater options rewards employees for poor performance while proponents counter that repricing is necessary to retain employees and motivate future performance.
Repricing and Company Performance Studied
The study, "Employee Stock Options and Future Firm Performance: Evidence from Option Repricings," co-authored by Ron Kasznik of Stanford University's Graduate School of Business, Nicole Bastian Johnson of the Haas School of Business at UC Berkeley, and David Aboody of UCLA's Anderson School of Management, looked at over 1,300 companies whose stock had declined by 30% or more annually from 1990 to 1996. Approximately 22% of those companies repriced; the study compared the performance of companies that repriced to those that didn't.
Overall, the study found that the companies that repriced performed better over one, three, and five years. More specifically, the study found that companies that repriced only options held by executives outperformed the companies that did not reprice. On the other hand, companies that repriced only options held by non-executives did not outperform the companies that did not reprice.
Broad Implications for Stock Options
The authors hypothesize that this indicates that granting options to rank-and-file employees doesn't enhance company performance. I haven't read the whole study (not because I'm lazy--although that's certainly a contributing factor--but because I can't seem to access a copy of it for a nominal cost and, given how inscrutable the last study I blogged about turned out to be--see my August 18 entry, "Section 6039 and the Recession," I'm not willing to make much of an investment here), but, according to the abstract, the authors assumed that once the options were underwater, any incentive effect they were having disappeared and that repricing the options would restore this incentive. If company performance didn't improve after the repricing, I guess (emphasis on "guess," as the reasoning that led to the conclusion isn't clear from the abstract) the authors assumed that the options weren't creating any incentive to begin with.
I Have Some Doubts
I'm not sure I'd make that leap--granted, I know next to nothing about conducting studies like this, but it seems to me that if you're going to argue a point about the incentive effect of stock options, you ought to include some companies that don't grant options as a control in the study.
It also seems like there are any number of other reasons why the repricings might not have improved company performance. For example, the rank-and-file employees could have lost faith in the options as a result of their being underwater and, while the repricing may have fixed the immediate tangible problem of the options being underwater, it may not have done anything to address the larger intangible issue of employees no longer believing in the company's future growth potential. While this would impact the incentive effect of the repriced options, it doesn't necessarily mean the options weren't having an incentive effect before they were underwater. Or employees could be anticipating future repricings if the stock price declines further. Or, an even simpler explanation could be that the repriced options didn't remain in-the-money--it isn't clear from the survey abstract that the authors considered this.
The study also doesn't say anything about retention--one of the primary reasons companies cite for undertaking repricings and option exchange programs. Valuation specialists have told me that in-the-moneyness is an important factor in estimating expected forfeitures, which leads me to believe that repricings could have their intended impact when it comes to retention.
Moreover, I've got to believe that the number of companies that repriced options held by executives only is a pretty small sample. Seriously, who does this? So I wonder how meaningful that data is.
Finally, what about the companies that repriced both executive and non-executive options? How did they perform?
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Last Chance for NASPP New Member Referral ProgramThe NASPP's New Member Referral Program ends this Friday, September 3. Any members you refer that join by this Friday receive 50% off their NASPP membership and you get $150 off your NASPP Conference registration (and an entry in our raffle for an iPad). Don't wait--all memberships have to be completed by this Friday to qualify.
NASPP "To Do" ListWe have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing "to do" list for you here in my blog.
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